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By the end of this section, you will be able to:

  • Explain how insurance works
  • Identify and evaluate various forms of government and social insurance
  • Discuss the problems caused by moral hazard and adverse selection
  • Analyze the impact of government regulation of insurance

Insurance is a method that households and firms use to prevent any single event from having a significant detrimental financial effect. Generally, households or firms with insurance make regular payments, called premiums . The insurance company prices these premiums based on the probability of certain events occurring among a pool of people. Members of the group who then suffer a specified bad experience receive payments from this pool of money.

Many people have several kinds of insurance: health insurance that pays when they receive medical care; car insurance that pays if they are the driver in an automobile accident; house or renter’s insurance that pays if possessions are stolen or damaged by fire; and life insurance, which pays for the family if the principal dies. [link] lists a set of insurance markets.

Some insurance markets
Type of Insurance Who Pays for It? It Pays Out When . . .
Health insurance Employers and individuals Medical expenses are incurred
Life insurance Employers and individuals Policyholder dies
Automobile insurance Individuals Car is damaged, stolen, or causes damage to others
Property and homeowner’s insurance Homeowners and renters Dwelling is damaged or burglarized
Liability insurance Firms and individuals An injury occurs for which you are partly responsible
Malpractice insurance Doctors, lawyers, and other professionals A poor quality of service is provided that causes harm to others

All insurance involves imperfect information in both an obvious way and in a deeper way. At an obvious level, future events cannot be predicted with certainty. For example, it cannot be known with certainty who will have a car accident, become ill, die, or have his home robbed in the next year. Imperfect information also applies to estimating the risk that something will happen to any individual. It is difficult for an insurance company to estimate the risk that, say, a particular 20-year-old male driver from New York City will have an accident, because even within that group, some drivers will drive more safely than others. Thus, adverse events occur out of a combination of people’s characteristics and choices that make the risks higher or lower and then the good or bad luck of what actually happens.

How insurance works

A simplified example of automobile insurance might work this way. Suppose that a group of 100 drivers can be divided into three groups. In a given year, 60 of those people have only a few door dings or chipped paint, which costs $100 each. Another 30 of the drivers have medium-sized accidents that cost an average of $1,000 in damages, and 10 of the drivers have large accidents that cost $15,000 in damages. For the moment, let’s imagine that at the beginning of any year, there is no way of identifying the drivers who are low-risk, medium-risk, or high-risk. The total damage incurred by car accidents in this group of 100 drivers will be $186,000, that is:

Questions & Answers

how is the graph works?I don't fully understand
Rezat Reply
multiple choice question
Aster Reply
explain perfect market
Lindiwe Reply
In economics, a perfect market refers to a theoretical construct where all participants have perfect information, goods are homogenous, there are no barriers to entry or exit, and prices are determined solely by supply and demand. It's an idealized model used for analysis,
Ezea
What is ceteris paribus?
Shukri Reply
other things being equal
AI-Robot
When MP₁ becomes negative, TP start to decline. Extuples Suppose that the short-run production function of certain cut-flower firm is given by: Q=4KL-0.6K2 - 0.112 • Where is quantity of cut flower produced, I is labour input and K is fixed capital input (K-5). Determine the average product of lab
Kelo
Extuples Suppose that the short-run production function of certain cut-flower firm is given by: Q=4KL-0.6K2 - 0.112 • Where is quantity of cut flower produced, I is labour input and K is fixed capital input (K-5). Determine the average product of labour (APL) and marginal product of labour (MPL)
Kelo
yes,thank you
Shukri
Can I ask you other question?
Shukri
what is monopoly mean?
Habtamu Reply
What is different between quantity demand and demand?
Shukri Reply
Quantity demanded refers to the specific amount of a good or service that consumers are willing and able to purchase at a give price and within a specific time period. Demand, on the other hand, is a broader concept that encompasses the entire relationship between price and quantity demanded
Ezea
ok
Shukri
how do you save a country economic situation when it's falling apart
Lilia Reply
what is the difference between economic growth and development
Fiker Reply
Economic growth as an increase in the production and consumption of goods and services within an economy.but Economic development as a broader concept that encompasses not only economic growth but also social & human well being.
Shukri
production function means
Jabir
What do you think is more important to focus on when considering inequality ?
Abdisa Reply
any question about economics?
Awais Reply
sir...I just want to ask one question... Define the term contract curve? if you are free please help me to find this answer 🙏
Asui
it is a curve that we get after connecting the pareto optimal combinations of two consumers after their mutually beneficial trade offs
Awais
thank you so much 👍 sir
Asui
In economics, the contract curve refers to the set of points in an Edgeworth box diagram where both parties involved in a trade cannot be made better off without making one of them worse off. It represents the Pareto efficient allocations of goods between two individuals or entities, where neither p
Cornelius
In economics, the contract curve refers to the set of points in an Edgeworth box diagram where both parties involved in a trade cannot be made better off without making one of them worse off. It represents the Pareto efficient allocations of goods between two individuals or entities,
Cornelius
Suppose a consumer consuming two commodities X and Y has The following utility function u=X0.4 Y0.6. If the price of the X and Y are 2 and 3 respectively and income Constraint is birr 50. A,Calculate quantities of x and y which maximize utility. B,Calculate value of Lagrange multiplier. C,Calculate quantities of X and Y consumed with a given price. D,alculate optimum level of output .
Feyisa Reply
Answer
Feyisa
c
Jabir
the market for lemon has 10 potential consumers, each having an individual demand curve p=101-10Qi, where p is price in dollar's per cup and Qi is the number of cups demanded per week by the i th consumer.Find the market demand curve using algebra. Draw an individual demand curve and the market dema
Gsbwnw Reply
suppose the production function is given by ( L, K)=L¼K¾.assuming capital is fixed find APL and MPL. consider the following short run production function:Q=6L²-0.4L³ a) find the value of L that maximizes output b)find the value of L that maximizes marginal product
Abdureman
types of unemployment
Yomi Reply
What is the difference between perfect competition and monopolistic competition?
Mohammed
what are y=b+mx
Deva Reply
The equation y = b + mx represents a linear equation in slope-intercept form, where y is the dependent variable, x is the independent variable, m is the slope, and b is the y-intercept. The slope-intercept form of a linear equation is commonly written as y = mx + b, where m represents the slope of
Steven
Consider the following Total Revenue (TR) and Total Cost (TC) functions for a firm operating in a perfect competition market: TR = 6Q and TC = Q3 – 2Q2 + 50Q + 25 Determine the profit maximizing or loss minimizing equilibrium level of output. Compute the level of
Abdulwab Reply

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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