What is the Rothschild Stiglitz model?
ABSTRACT. In their seminal work, Rothschild and Stiglitz (1976) have shown that in. competitive insurance markets, under asymmetric information, pooling. contracts cannot exist in equilibrium, firms make zero profit, and, under some circumstances, equilibrium does not exist.
Under what conditions a separating equilibrium may also not exist?
When the distortion associated with self-selection is too large, there is always a pooling contract (purchased by high and low risk individuals) that will be preferred, in which case the “separating” equilibrium cannot be sustained. In this case, there exists no competitive equilibrium.
How equilibrium is achieved in an insurance market?
Equilibrium in a competitive insurance market is a set of con- tracts such that, when customers choose contracts to maximize ex- pected utility, (i) no contract in the equilibrium set makes negative expected profits; and (ii) there is no contract outside the equilibrium set that, if offered, will make a nonnegative …
Why the most important conclusions of economic theory are not robust to considerations of imperfect information?
Some of the most important conclusions of economic theory are not robust to considerations of imperfect information. We are able to show that not only may a competitive equilibrium not exist, but when equilibria do exist, they may have strange properties.
What is an example of adverse selection?
An example of adverse selection in the provision of auto insurance is a situation in which the applicant obtains insurance coverage based on providing a residence address in an area with a very low crime rate when the applicant actually lives in an area with a very high crime rate.
Would low productivity workers prefer a pooling equilibrium?
Answer: No. Under the pooling equilibrium the low–ability workers are unam- biguously worse off. Their wage declines from $7.50 to $5.00. The high ability workers receive a higher wage and so can be better off.
What is adverse selection Econ?
adverse selection, also called antiselection, term used in economics and insurance to describe a market process in which buyers or sellers of a product or service are able to use their private knowledge of the risk factors involved in the transaction to maximize their outcomes, at the expense of the other parties to …
What is lemons problem in economics?
The lemons problem refers to the issues that arise regarding the value of an investment or product due to the asymmetric information available to the buyer and seller. The lemon theory posits that in the used car market, the seller has more information regarding the true value of the vehicle than the buyer.
Is adverse selection bad?
Adverse selection occurs when there is asymmetric (unequal) information between buyers and sellers. This unequal information distorts the market and leads to market failure. Sellers of second-hand goods may have better information about the true quality of the good than buyers.
What is the difference between a pooling and separating equilibrium?
A pooling equilibrium is an equilibrium in which all types of sender send the same message. A separating equilibrium is an equilibrium in which all types of sender send different messages.