Author Question: How do adverse selection and moral hazard affect the market for insurance? What will be an ideal ... (Read 233 times)

rosent76 · **on:** Jun 29, 2018

How do adverse selection and moral hazard affect the market for insurance?

What will be an ideal response?

Question 2

In Problem 14, do firms enter or exit the market in the long run? What is the market price and the equilibrium quantity in the long run?

What will be an ideal response?

Sierray · **Reply #1 on:** Jun 29, 2018

Answer to Question 1

Both adverse selection and moral hazard drive up the price of insurance. People with a higher probability of the insurable outcome are the ones who buy the insurance (adverse selection), and having insurance increases the probability of the insurable outcome occurring because the person no longer tries as hard to avoid the outcome (moral hazard). Adverse selection and moral hazard may drive the price up so much that some people don't want to buy the insurance.

Answer to Question 2

The firms are incurring economic losses, so some firms exit the market. As firms exit the market, the market supply decreases so that in the long run the price rises to equal the minimum average total cost, 4.25 per smoothie. When the price is 4.25 for a smoothie, the equilibrium quantity is 550 smoothies per hour.