Answer to Question #50484 in Microeconomics for nidhi

Question

Write short notes on any two of the following: (a) Envelope theorem (b) Hidden information (c) Actuarially Fair Premium

Answer 1

The envelope theorem is a very convenient tool for the analysis of so-called "comparative statics", i.e. analysis of the impact of small changes in the parameters on the characteristics of the equilibrium state. The envelope curve theorem states that if the two processes are described by smooth curves, the slope of the envelope curve should be the same as that of the curve describing each of the processes, at the point where it was applied. This means that the ultimate product used for all processes must be the same and equal to the product of the combination of the limiting processes. If the angles are not equal, it means that it is possible to achieve the best results due to increased use of the process and reduce the use of another process.

The actuarially fair premium is defined as the expected loss for the insurance company. For insurance to be actuarially fair, the premium rate must equal the probability of an accident. In actual practice, even if the premium does not equal the probability of an accident, it certainly depends on it - which is why different demographic groups pay widely differing automobile insurance premiums.