The following questions test your knowledge of the concept o…
The following questions test your knowledge of the concept of adverse selection. a. In adverse selection models, different individuals have different probabilities of falling ill. Why can’t the insurer set premiums proportionately to this probability of illness, e.g. high premium plans to frail individuals, low premium plans to healthy individuals? b. Consider two people with the same risk aversion. Is a person with higher probability of illness willing to pay more or less for insurance? c. Consider two people with the same probability of illness. Is a person with higher risk aversion willing to pay more or less for insurance? d. Suppose everyone has the same level of risk aversion. What will be the shape of the marginal cost faced by the insurer? e. Suppose everyone has varying levels of risk aversion. Under what condition will the marginal cost curve faced by the insurer be upward sloping?