Question

1. What is the value of insurance to a risk-averse consumer?

2. What characteristics of a market can create the lemons problem?

Answer 1

1) Investors typically fall into three categories of risk tolerance, namely aggressive (those investors who are risk tolerant), conservative (those investors who are risk averse), or moderate (those investors who are somewhere in between). The more conservative the society is, the less risk the investor would take, and the less potential will have to earn a high return (though investors also less likely to lose on the investment). Thus a risk-averse person would be willing to pay higher than the actuarially fair premium.

2) The lemons problem refers to issues that arise regarding the value of an investment or product due to asymmetric information possessed by the buyer and the seller. Thus it occurs in the market where there is asymmetric information between buyers and sellers, or between investors and entrepreneurs. Thus lemon problem occurs when there an unequal amount of information between the buyer and seller on an informed decision regarding a transaction.