Question

Consider the following story:

Diversifun, Inc., an insurance company, recently decided to offer boat insurance. Diversifun was concerned that the most likely boat insurance customers would be the least competent, highest-risk boat captains, because they stand to benefit most from boat insurance coverage. Since Diversifun cannot distinguish perfectly between high-risk and low-risk skippers, it decided to set its boat-insurance premiums a bit higher to account for the foolhardy sea captains.

The economic problem in this story is known as:

A) Adverse selection

B) Signaling

C) Moral hazard

D) Screening

Answer 1

The economic problem in the story is known as Adverse Selection as Adverse selection is the tendency of those in risky jobs or high risk lifestyles to get life insurance. It is a situation where sellers have information that buyers don't (or vice versa) about some aspect of product quality.