Question

When, how, and why did financial institutions begin and evolve in the United States?

A. Are financial institutions an independent clause, a complement, or simply just a consequence of economic growth?

B.What are the problems of adverse selection and moral hazard in the market for health insurance?

Answer 1

Part A)

Most Financial Institutions are established in an economy to stabilize an existing anomaly in the market place, to promote trade and to bring in additional revenue, demand and income for the country. The United States of America is no different. It has established Financial Institutions from time to time so as to help its economy in growing which has largely developed to become one of the world’s leading economies, the currency of which is widely accepted for all global trade among countries.

In this regard, Financial Institutions are of various type such as the Federal Reserve which was created in the year 1913 and has since then helped the economy in maintaining liquidity in the market as well as has been a critical reason for the long-term growth and development. The institution has been pivotal in providing relief to the economy from various recessions or inflation such as the 2008 Financial Crisis which developed as a result of the Housing bubble or the current Covid 19 situation wherein the economy is again experiencing a tough phase.

We see evidence, that the creations of institutions like these, have been complementary to economic growth and are not independent or exist as supplements to growth. For example, in the era before the 1913 establishment of the Federal Reserve, the economy was going through a period wherein customers would rush to banks to withdraw all of their money at once. Once the reserve was established, it acted as a catalyst towards economic growth as investors became confident of the amount being deposited in banks.

We can conclude by saying, that Financial Institutions come into existence, to solve an existing issue or problem and they act as compliments towards economic growth and progress. They have been numerous types of institutions such as the example explained above, and some other examples include the likes of Security and Exchange Commission or the Consumer Financial Protection Bureau all of which act as compliments towards bringing economic growth and progress in the country.

Part B)

The problem of adverse selection in economics takes place, when one of the parties to a transaction has higher knowledge about the transaction than the other party. This usually results in losses for the seller or the buyer whichever has a lack of knowledge in the transaction.

In the health care insurance sector, the buyer of a policy is well aware if any medical condition is troubling them and has not yet been reported. For example, a person may get frequent spells of fever which may indicate a health problem, but if this has not been checked by an independent doctor, there is no need for the buyer to report the same as part of the insurance contracts of a firm. This then results in a situation wherein the prices of the insurance contract are not fare for the seller as he is unaware of these developments and health problems in the future could lead to loss of revenue both from pricing of the insurance plan as well as the pay-out which the firm needs to make later.

Now, coming over to the problem of moral hazard, this as per economists takes place, when a person takes more risks due to the fact that that risk is covered by a third party. For example, in case of health insurance, a person is aware that his medical expenses would be borne by the insurance company, and he may then lead a unhealthy lifestyle as he is aware of the fact that the cost associated with medical expenses would not be borne by the person but rather by the insurance company respectively.

Please feel free to ask your doubts in the comments section.