PART 1: Classify each of the following scenarios as an example of adverse select

Question

PART 1: Classify each of the following scenarios as an example of adverse selection or moral hazard. Be sure to support your answer!

1. Nordstrom’s cannot predict who is going to be a good shoe salesperson.

2. A health insurance policy that has no deductibles and unlimited use of chiropractic visits is used to the maximum allowed by some patients.

3. Poor drivers seek out car insurance more than good drivers do.

4. Airline companies offer an expensive ticket that allows you to fly immediately and a lower-priced ticket with more flexible use.

5. CEOs shirk and do not maximize the company’s profits.

PART 2: Discuss why, if most people are risk-averse, they gamble. What do YOU think?

Also, please post at least two comments to your fellow classmates.

Explanation / Answer

1. Nordstrom’s cannot predict who is going to be a good shoe salesperson. - Adverse Selection

2. A health insurance policy that has no deductibles and unlimited use of chiropractic visits is used to the maximum allowed by some patients. - Moral Hazard

3. Poor drivers seek out car insurance more than good drivers do. - Adverse Selection

4. Airline companies offer an expensive ticket that allows you to fly immediately and a lower-priced ticket with more flexible use.- Moral Hazard

5. CEOs shirk and do not maximize the company’s profits. Moral Hazard

Part 2 Decision makers who are sensitive

to global properties of gambles will weight the interval by which they could improve over the

minimum by different amounts. For some, the possibility (with some specific probability) of

improving over the minimum by some amount might not count heavily in the evaluation of the

gamble – on the contrary, the minimum they are guaranteed to receive will be more important.

These people will display risk averse behavior: if two gambles yield the same monetary value on

average, but one yields a specific amount no matter what (and therefore that gamble has a higher

minimum), they will prefer the latter. For others, the possibility of improving over the minimum

will count for a lot – and the maximum they might receive will count heavily in the evaluation of

the gamble.

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