There are two types of drivers, safe types who have an annual probability of getting in...
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There are two types of drivers, safe types who have an annual probability of getting in an accident of 10% and risky types who get in a car crash with probability 20%. Each type represents half of the population. When a car crash occurs, it costs the insurance company $10,000. This problem is about asymmetric information, specifically in insurance markets. To answer this question, it helps to understand insurance. Insurance contracts work in the following way. The amount that the insurer pays in the event of an accident is Payout (Accident cost-Deductible) *Coinsurance rate. The rest is paid by the individual. The expected value of a firm's expenses are E[Payout] = (probability of an accident) Payout. The insurance premium is the price the consumer pays for insurance. It is paid regardless of whether there is an accident. Therefore, the insurer's expected profit= Premium - E[Payout]. a. Suppose the insurer offered only one type of contract: deductible=0 and coinsurance rate = 100%. What's the expected value of the insurer's payout for safe types? What about the risky types? b. What insurance premium would cause the company to break even? Would both types buy car insurance? d. Describe how mandating insurance purchase would affect the market. e. Suppose the insurance company began offering a menu of plans. One plan had no deductible and a premium of $2000. Another plan had a $3000 deductible, but only had a premium of $700. Which menu option would each type select? The government wants to regulate carbon emissions. After careful study, it estimates that the marginal benefit to society of abating emissions as well as the marginal cost to firms of installing pollution reducing technology as MCA = 100+ Q/2 and MBA = 1000-2Q where Q = the number of tons of the pollutant. (a) Draw the marginal cost and marginal benefit of abatement. What do you suppose is the private marginal benefit of abatement? (b) Given the estimates of the marginal cost and benefit of abatement. What would be the optimal emissions tax to set? (c) Some uncertainty exists in your calculation of the marginal cost of abatement - the cost of abatement may in fact be substantially higher. If the marginal cost of abatement is actually MCA = 200 + Q/2, what is the deadweight loss associated with using the tax from part (a) relative to the optimal tax rate. (d) Repeat part (c) under the assumption that the government had chosen to use command and control regulation instead. There are two types of drivers, safe types who have an annual probability of getting in an accident of 10% and risky types who get in a car crash with probability 20%. Each type represents half of the population. When a car crash occurs, it costs the insurance company $10,000. This problem is about asymmetric information, specifically in insurance markets. To answer this question, it helps to understand insurance. Insurance contracts work in the following way. The amount that the insurer pays in the event of an accident is Payout (Accident cost-Deductible) *Coinsurance rate. The rest is paid by the individual. The expected value of a firm's expenses are E[Payout] = (probability of an accident) Payout. The insurance premium is the price the consumer pays for insurance. It is paid regardless of whether there is an accident. Therefore, the insurer's expected profit= Premium - E[Payout]. a. Suppose the insurer offered only one type of contract: deductible=0 and coinsurance rate = 100%. What's the expected value of the insurer's payout for safe types? What about the risky types? b. What insurance premium would cause the company to break even? Would both types buy car insurance? d. Describe how mandating insurance purchase would affect the market. e. Suppose the insurance company began offering a menu of plans. One plan had no deductible and a premium of $2000. Another plan had a $3000 deductible, but only had a premium of $700. Which menu option would each type select? The government wants to regulate carbon emissions. After careful study, it estimates that the marginal benefit to society of abating emissions as well as the marginal cost to firms of installing pollution reducing technology as MCA = 100+ Q/2 and MBA = 1000-2Q where Q = the number of tons of the pollutant. (a) Draw the marginal cost and marginal benefit of abatement. What do you suppose is the private marginal benefit of abatement? (b) Given the estimates of the marginal cost and benefit of abatement. What would be the optimal emissions tax to set? (c) Some uncertainty exists in your calculation of the marginal cost of abatement - the cost of abatement may in fact be substantially higher. If the marginal cost of abatement is actually MCA = 200 + Q/2, what is the deadweight loss associated with using the tax from part (a) relative to the optimal tax rate. (d) Repeat part (c) under the assumption that the government had chosen to use command and control regulation instead.
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Related Book For
Income Tax Fundamentals 2013
ISBN: 9781285586618
31st Edition
Authors: Gerald E. Whittenburg, Martha Altus Buller, Steven L Gill
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