Homework Clinic
Social Science Clinic => Economics => Topic started by: clmills979 on Jun 29, 2018
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Explain the moral hazard that automobile insurance companies face. What methods do they employ to try to mitigate this problem? Explain carefully.
What will be an ideal response?
Question 2
Why do economists mostly use optimization in differences, as opposed to optimization in levels?
What will be an ideal response?
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Answer to Question 1
Once people have acquired automobile insurance and know that when an accident occurs a third party (this case the insurance company) will pay the repair bill this might have the effect of people driving less carefully than otherwise. Automobile insurance companies can mitigate this somewhat by having people pay graduated deductibles. That is the insured is responsible for at least part of the repair bill. The less risk they wish to take in the form of a lower deductible will simply be built into a higher insurance premium and vice versa.
Answer to Question 2
For the sake of simplicity and intuition, economists mostly use optimization in differences. Optimization in differences is simple because everything else about the two alternatives that are being compared except the particular attributes that are different can be ignored. For example, suppose that two apartments are both near good restaurants, both have good access to public transportation, and both have a Laundromat down the street. The two attributes that are different, for instance rent and street noise, are compared while ignoring all the attributes that are the same about the two apartments.
Optimization in differences is also intuitive. When comparing two options, it makes sense to focus on what makes them different. Marginal analysis emphasizes this point, by comparing differences instead of levels.