【正文】 n How do insurance panies mitigate this problem? ? Offer different packages: ? 1. Deductibles – the amount of medical expenditures the person has to pay before the plan starts paying benefit ? risky people reveal themselves by choosing low deductibles ? 2. Do not cover preexisting condition Other examples of adverse selection Another Adverse Selection Example ? Used Cars ? Why does your new car drop in value the minute you drive it off the lot? Another Adverse Selection Example – used Cars ? First assume that there are two kinds of used cars lemons and peaches. Lemons are worth $5,000 to consumers and peaches are worth $10,000. Assume also that demand is perfectly elastic and consumers are risk neutral. There is a demand for both kinds of cars and a supply of both kinds of cars. ? Is the supply of lemons or peaches higher? Peaches Lemons P P Q of Peaches Q of Lemons D 10,000 5,000 D S S Q* (perfect info) Q* (perfect info) Another Adverse Selection Example – Used Cars ? Assume there is perfect information ? Buyers are willing to pay ___________ for a lemon and ___________ for a peach. Peaches Lemons P P Q of Peaches Q of Lemons D 10,000 5,000 D S S 5,000 10,000 Q* (perfect info) Q* (perfect info) Another Adverse Selection Example – Used Cars ? Case 1: Assume that buyers think that there is a 50% chance that the car is a peach. What is their expected value of any car they see? ? *$10000+*$5000 ? =$7500 ? If they are risk neutral, how much are they willing to pay for the car? ? $7500, indifferent between certain and uncertain ine Another Adverse Selection Example – Used Cars ? Case 2: Will the ratio of peaches to lemons stay at 50/50? If not, what will happen to the expected value? ? Demand for peaches falls, demand for lemons rises Peaches Lemons P P Q of Peaches Q of Lemons D 10,000 5,000 D S S 7,500 D(50/50) 7,500 D(50/50) Q* (.) Q* (.) ? Ratio shifts to fewer peaches and more lemons ? Expected value falls as beliefs about of lemons increases ? More peaches drop out. Q* (new) Q* (new) Another Adverse Selection Example – Used Cars ? Ultimately ? In the extreme case, no peaches, all lemons Peaches Lemons P P Q of Peaches Q of Lemons D 10,000 5,000 D S S 7,500 D(50/50) 7,500 D(50/50) Q* (.) Q* (.) Q* (new) Q* (new) What could you do to signal to someone that your car is not a lemon? ? Pay for a mechanic to inspect it. ? Offer a warranty on the car. ? Generally, offer something that is costly to fake. Role for the Government? ? Does the asymmetric info mean the gov’t can/should be involved? ? ? (look up the Lemon Law for MI) Other examples of signaling ? Brand names pany advertising ? Dividends versus Capital gains ? Football players ? How can you signal how good of an employee you will be? III. Full disclosure/Unraveling ? You’re on a job interview and the interviewer knows what the distribution of GPAs are for MSU graduates: ? Expected/Average grade for everyone: ? *1+*2+*3+*4 ? = ? The job counselor at MSU advises anyone who had a B average to volunteer their GPA. Is this a stable oute? Percent GPA or better What does the potential employer believe about the people who stay quiet? They know their GPA is below a , but how far below? III. Full disclosure/Unraveling ? Employers know their GPA is below a , but how far below? ? Expected/Average grade for those who don’t reveal: Percent GPA ? *1+*2 ? = ? Therefore, those w/ a should reveal…unravels so that there is full disclosure. Those who don’t reveal: Original percent divided by what share of students remain = = Intuitively, those who are above the expected average don’t want employers to think they are average, so they disclose! Intuition check ? What does this full disclosure principle say about whether only peaches will provide a signal of their value? Voluntary disclosure and SAT scores ? Institutional Details ? Voluntary disclosure question ? Data ? Results Institutional Details ? Increasing of schools are adopting policies where submitting your SAT scores are optional ?., students can submit high school ., extracurricular activities etc, and exclude standardized test score on their application ?School will judge based on submitted material Voluntary disclosure question ? If it is fairly costless to reveal your scores, all by the students with the lowest scores should reveal to avoid being considered the “average” of those who don’t reveal. ? Is it only the students with very low SAT scores that don’t reveal? Data ? Liberal arts college ?1800 students ?Mean SAT score 1300 (out of 1600) ?1020 is the mean SAT score of those who take it