Before selling anyone a health insurance policy, the
Kramer Insurance Company requires that applicants
undergo a medical examination. Those with signifi-
cant preexisting medical problems are charged more.
This is an example of
a. moral hazard.
b. adverse selection.
c. signaling.
d. screening.

Answer

d. screening.

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Principles of Microeconomics

Chapter 22

Frontiers of Microeconomics

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Video Transcript

this problem deals with the case of asymmetric information, which is when the buyer and the seller have an equal info. And in most cases, one of the other parties has good info and the other has bad info. In this case, the Cramer insurance company is the screening medical screening applicants for their medical histories to determine if they have pre existing conditions. Because the Cramer insurance company doesn't already have that information, they are the ones with the bad info in this case. So let's go through the options. Moral hazard. Moral hazard is, um, an action by a party of good info, Um, and then it includes when that party misleads the other party or changes their behavior after the agreement has occurred. Um, for example, if you get flood insurance and then you don't prepare as well for a flood afterwards, that is an example of moral hazard because you're raising the risk that you will have flood damage. Um, so in the case of this problem, well, hazard cannot be the right answer, because it is. It deals with a party of good info. And that's not what Cramer Insurance is in this case. Um, adverse selection, so adverse selection just deals with an equal information about of that two different parties have. And if that unequal information doesn't get fixed, um, that can lead to adverse selection, which is when unequal info leads to inefficient pricing. And that is what Cramer Insurance is trying to avoid by doing these screenings or one of the things that they're trying to avoid. So therefore, adverse selection can't be the answer, because that's result of these screenings or not doing these screenings and not a reason for it. Signaling so. Signaling is also an action done by a party of good information. And signaling occurs when the company wants to show that their product, um, or whatever they're trying to sell is better then the person, or just to convey, simply convey more information about it. Two. The buyer who is who may not be as informed or vice versa. But again, this is the case of the party with good information having it so signaling also cannot be the answer. Lastly, screening and screening occurs, Um, when a party of bad information when a party of bad information, um, wants to filter wants to filter helpful from useless info. And not only does this answer work because it's the only one, um, with by a party of bad information, but it also applies in this problem because that is what Cramer Insurance is trying to do. They're trying to filter, um, the helpful from the use of information in regards to each person's medical history.

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