Hello there, Please find the below picture for the questions to answer. The word
ID: 2601515 • Letter: H
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Hello there,Please find the below picture for the questions to answer. The word limit is 500words so please devide on to the number of questions, you may for example use more words in one questions than the other which is fine. As long as it 500 words in total to answer all the questions. Not 500 words for each question.
Hello there,
Please find the below picture for the questions to answer. The word limit is 500words so please devide on to the number of questions, you may for example use more words in one questions than the other which is fine. As long as it 500 words in total to answer all the questions. Not 500 words for each question.
Paragraph Font Area 2- The common pool 1. Can you explain the principles behind the common pool? 2. Can you explain how the Law of Large Numbers (LLN) operates? 3. Does the LLN have any limitations? i.e. are there specific types of losses/risks which are problematic for the LLN? 4. What is adverse selection and what are moral hazard? 5. what implications do they create for the common pool and insurance companies? 6. How might these be reduced?
Explanation / Answer
Ans 1. Principles behind the common pool
Meaning: Assets that are jointly mamaged by the group rather than by an individual.Here the member of the group gets the benefit individually but have to bear the cost collectively. the overuse of resources will lead to scarcity
Common-pool resources such as forests are often managed by a combination of governments and markets. This can be done by only allowing a certain amount of the resource to be used over a period of time avoiding in overuse of resources.
Example: A fishery can sustainably yield 100,000 pounds of fish annually and the market price of a pound of fish is $5. Ten companies agree to harvest 10,000 each. In the absence of regulation, each company would harvest more than its allotted quota in order to sell more fish at $5 a pound. If each company over harvests by 1,000 pounds the fishery will over harvested by 10,000 pounds, and will not be able to produce the same level next year.
Ans2: Law of large number
Meaning: It means the result of performing the same experiment a large numbe of times. The more the trials perfomed the result will be close to the expected value.
example.a.: If a coin is tossed 1000 times , we can assume half of the tosses can come up as tail and half as head. the ratio will be close to 1:1. At the same time if we toss 10 times the ratio will be different may be even or odd or combination of both.
Example .b.. INSURANCE SECTOR:Benefits of using the law of large numbers in Insurance sector is to insure a group in order to avoid credit risk by charging a premium that reflects probable losses before the losses occur and to charge a more stable premium.
Ans 4. Adverse selection:Adverse selection occurs when one party in a negotiation has relevant information the other party lacks in other words where sellers have information that buyer donot about product or services being offered.
Moral hazard: Moral hazard is a situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost. both the parties have incomplete information about each other.
Ans 5.a. Moral hazards in common pool can be well explained with the example of a River.e.g. Water is available to everyone from the river.The manufacturing plant and the city benefits from the river jointly, but if the plant dumps pollution into the river it cannot be used by the city for drinking water. Here everyone enjoys the benefits of water individually but the cost of polluting the river will be incurred by all even if manufacturing plant was responsible in polluting it.Overutilization and inefficient way of using resources lead to such hazards.
b. Insurance companies:When the customer base increases the underwriting risk also increases.Insurance companies expect losses in their business but the company also collects more premiums to finance those losses. Infact premiums grow faster than the underwriting risk. Because of adverse selection, a company selling insurance finds people at higher risk of death are more willing to buyand pay greater premiums for policies. For example, a life insurance company charges higher premiums for race car drivers. A car insurance company charges more for customers living in high crime areas etc..Moral Hazard:Insurance companies worry that by offering huge claims to protect against losses from accidents, they may actually encourage risk-taking, which results in them paying more in claims. lack of incomplete information about policies and claims will lead to losses by an individual.
I hope this answer helps
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