Explain the nature and consequences of asymmetric information for each

Explain the nature and consequences of asymmetric information for each of the following cases. What options are available in each instance to reduce the problem?

a. medical insurance
b. issuance of credit cards
c. professional athletes
d. market for used appliances

ANSWER

a. Medical insurance is susceptible to adverse selection, since unhealthy people are more likely to want insurance than healthy individuals. A premium based on the incidence of claims among the general population will be too low. Remedies include medical examinations, medical histories, and refusal to cover pre-existing conditions.
b. The credit problem arises when all customers must be charged the same rate. Poor credit risks find the rate attractive and apply for credit in disproportionate numbers. The interest rate based on average bad loan rates will be too low. To protect from this bias, credit companies can share credit histories.
c. Professional athletes become a problem when free agency is allowed. The athlete’s existing team has more information regarding the players’ health than a new team. The expectation is that free agent players have higher disability rates than renewed players. To protect against this problem, professional franchises should require medical examinations and insist on clauses that void the contract if medical conditions are concealed.
d. Markets for used appliances can be segmented according to quality. Buyers have an incentive to regard all appliances as being low quality. This depresses the price and reduces the availability of high appliances relative to the number that would exist with better information. The main solution is for sellers of high quality articles to provide warranties.