Question

3. Suppose you are in the market for a used treadmill and find a Nordic Track Commercial 2150 on sale for $1000. If you knew the motor was in good condition, you would be willing to pay $1,400. Meanwhile, if you knew the motor was only in fair condition, you would only be willing to pay $400 for the treadmill. Explain the circumstances under which you would be willing to purchase the treadmill for $900.

a) Please supply an example of a health-related firm that operates in a monopolistically competitive market. Then, provide a 4-5 sentence explanation in support of your choice.

Answer 1

It is given that the second-hand treadmill is on sale for $1000. Thus, different quality of treadmills are available, that is treadmill is in either good condition or fair condition. It is given that for the different conditions, willingness to pay of consumer varies, that is, for good condition willing to pay $1400 and for fair condition willing to pay $400.

Thus, if the consumer has incomplete information about the condition of the treadmill, then the consumer is willing to pay an average price, that is, an average of willingness to pay for fair and good condition treadmill which is computed as follows -

Thus, under the circumstances of incomplete information about the condition of treadmill consumer is willing to pay 900.

Part a) Health insurance company (that is, only policy provider in the insurance market) who provide insurance against the health risk to the policyholder. The potential customer has different probabilities of getting ill, that is, a smoker (the bad type) has a higher chance of failure of lungs then a non-smoker (the good type). And which is why compensation payments made by the insurance company, if any loss occurs, will differ for a different policyholder of varying smoking habit. The insurance company would be willing to sell more policies to the good type of insuree (as a lower need for paying compensation as a lower probability of getting ill). Thus, their willingness to charge a premium (the amount charged by the insurance company for selling the insurance policy) from the good type differs from the bad type. But, in a scenario of incomplete information with the insurance company, the company is unaware of the type of insuree, that is, whether the policy purchaser is a good type or bad type. The insurance firm is willing to charge an average premium, that is, an average of willingness to charge premium from the good type and willingness to charge premium from bad type.