Answer to Question #122993 in Microeconomics for shaa

Question

Using appropriate models, analyse market outcomes for comprehensive car insurance in the following way:

(a) Analyse how a risk-averse individual makes decisions facing uncertainty. (10 Marks)
(b) Analyse the best pricing strategies for insurance firms, assuming that there are individuals with different levels of risk aversion and that the firms in this market collude in their pricing strategies. (5 Marks)
(c) Discuss how the outcomes in (b) would differ if you assumed perfect competition. (5 Marks)
(d) Discuss the outcomes when the suppliers lack information about the level of risk facing each potential insuree. Carefully explain why some potentially beneficial economic transactions can “go missing” in the presence of this information asymmetry. (10 Marks)

Answer 1

a.Risk averse people are most inclined to purchase insurance. Because they prefer certain income over risky income, because they are willing to pay to avoid risk, they are prime candidates for insurance. They pay a small premium, which gives them a lesser amount of guaranteed, certain income, but in so doing they do not face the risk of a larger loss of income.

b.Insuarance pricing strategies.

Schedule rating method.This method of pricing uses a baseline rate as a start point and then factor in other variables depending on the risk they carry.

Retrospective rating method.This method of pricing relies on the policy holders vactual claim and experience when setting pricing rates.

Experience rating pricing method.This pricing methods relies heavily on a policy holders past claim experience when determining what premium rates to charge.

c.Perfect competition is determined by the market demand and supply curves of the insuarences policies to be sold. The demand curve clearly indicates the total amount of a product that consumers are both willing and able to buy. On the other hand, the supply curve indicates the amount suppliers are willing and able to supply at certain market prices.The firms can only supply what the consumers can consume at given prices. In a perfectly competitive market structure, the market sets the price and firms are merely price takers and thus they will operate for as long as production costs fall below revenue.In a perfect competition profit is maximazed where marginal cost is equal to marginal revenue.

d.Asymmetric information in insuarence occurs when one party has more information than the other.In this case where an insuree has more information than the insurer,it may lead to near fraudulent consequences, such as adverse selectiona which describes a phenomenon where an insurance company encounters the probability of extreme loss due to a risk that was not divulged at the time of a policy's sale.