MSc Public Economics 201112 httpdarp.lse.ac.ukec426.ppt

MSc Public Economics 2011/12 http://darp.lse.ac.uk/ec426/ Policy Design: Social Insurance Frank A. Cowell Role of social insurance Insurance and social insurance Why should a social approach be necessary? Is this just classic market failure? Will society succeed where the market fails? Redistribution A role for society Why do it through an insurance mechanism? Paternalist management Merit good argument: health insurance? Failure of perception: life insurance? Overview of subject: Barr (1992) Diamond (2003) Design issues Game theoretic approach: Incomplete information Asymmetric information 1+n players 1 Government n Citizens Government makes first move Designs a menu of opportunities Citizen then makes choices in the light of the “menu” offered Could be work, saving, etc More on design theory next week Overview... Insurance problem: outline You are endowed with a risky prospect Value of wealth ex-ante is y0 There is a risk of loss L If loss occurs then wealth is y0 – L You can purchase insurance against this risk of loss Cost of insurance is k In both states of the world ex-post wealth is y0 – k Use a standard state-space diagram Attainable set: insurance Insurance problem: preferences Also from standard model of risk-taking Satisfy von-Neumann-Morgenstern axioms Can use concept of expected utility If p is probability of loss… …slope of indifference curve where it crosses the 45o line is – [1– p]/p Competitive market means actuarially fair insurance Slope of budget line given by –[1–p]/p... Strong implication for equilibrium, but… Outcome will depend on individual perceptions Equilibrium and perceptions Overview... Adverse selection: market model? Adverse selection models use one of 2 paradigms: Monopoly provision Can draw up menu of contracts Limited only by possibility of non-participation or misrepresentation Competitive model with free entry into the market Numbers determined by zero-profit condition What type of equilibrium will emerge? Will