Question

The nature of health care. a) Define the concept of “principal agent with asymmetric information” and discuss how it impacts health care markets.

b) Define incentive compatible contracts and give examples of how they are used to impact behavior.

Answer 1

In health care markets principal agent problem refers to a problem in determining managerial accountability that generally arises when delegating authority to its managers. When consumers lack information on a product quality, say an insurance policy, they are likely to offer an average price equal to the average value for all the insurance policies irrespective of good and bad. Asymmetric information means that high risk and low risk individuals enjoying full insurance at different costs. Asymmetric information is source of market failure in health care markets and it creates the problem of adverse selection.