II.C. Asymmetric Information, Market Failure, and Health Care

What are some possible solutions to the problem of market failure in case of health insurance?

-customers "self sort" ; Deductibles and co-pays also help with moral hazard problem - low-priced plan with high deductibles and co-pays: appeals to low-risk customers - high-priced plan with low deductibles and co-pays: appeals to high-risk customers -OR Insurance companies provide package deals to large employers -Can avoid adverse selection by requiring that ALL employees be covered -A counterproductive approach: Insurance companies may seek to protect themselvesfrom the consequences of adverse selectionThe "healthy tail" of the distribution flees the market (for the reasons given above) An insurance company may seek to offset this by chopping off the "unhealthy tail" at the other end of the distribution -Government: • Require people to buy insurance • Set up large pools from which individuals and small firms can buy insurance (public and private options) • Disallow denials based on pre-existing conditions (could be disastrous for insurance companies if there is adverse selection

"Asymmetric information" refers to a situation where

A) buyers have more information than sellers OR B) sellers have more information than buyers

Insurance companies can try to reduce the problem of adverse selection by

A) offering attractive rates to large companies if they mandate that all employees participate B) using price mechanisms that get buyers to reveal information about themselves

Which of the following groups are likely to suffer the most from market failure in the health insurance market?

A) people who must purchase insurance as individuals B) small businesses

Explain how asymmetric information can lead to market failure in the market for health insurance.

Insurance providers cannot asses the health risks of buyers case to case so they set a price based on average risk. Healthy buyers are less willing to pay this price and they drop out (adverse selection). This leads to an increase on average risk amongst the remaining customers. The seller raises prices, more drop out, etc...

What did Michael Spence propose as a (partial) solution to the problem of adverse selection?

Michael Spence suggested a "signaling" approach: Sellers can try to find ways to signal that they are reputable

Why might "moral hazard" exacerbate the problem of health insurance market failure?

Once people are insured, the cost of poor health is reduced (the insurance pays for treatment). As a result, people may not take as good care of themselves, raising average risk

Adverse Selection

The maximum price buyers are willing to pay is less than the value of the very best cars

A government mandate requiring everyone to purchase health insurance is designed to deal with the problem of

adverse selection

If high-quality used cars are pulled off the market because the market price is too low to adequately compensate sellers, we have a process known as

adverse selection

Asymmetric Information

buyers and sellers may have different information

In the market for health insurance, "moral hazard" refers to a situation where

buyers of health insurance have a diminished incentive to take care of themselves

In the market for used cars,

people with cars of very high quality will typically be unable to sell at a price that is commensurate with the quality of their cars

Michael Spence proposed a partial solution to the problem of aymmetric information for cases where sellers have more information. His solution involves

sellers finding ways to signal that they are reputable.

In the market for health insurance

sellers have less information than buyers about their underlying health risks