In Massachusetts car insurance is required of all drivers by

In Massachusetts car insurance is required of all drivers by law. However, there are concerns that the insurance market is not competitive, since it is very costly for insurance firms to vet policy holders (i.e. drivers). (Vet means to tell whether a driver is high or low risk.) In response, the state is mulling whether to enact a controversial law that makes it a crime for policy holders to mislead insurers. The law will also force all drivers to install a monitoring device in their cars that reports how fast the car is moving to the newly established Bureau of Road Rage.

The state has hired you to review the policy. Use what you know about competition and information asymmetry to discuss how this policy will affect the quality and price of insurance. You are also encouraged to discuss the tradeoffs between efficient markets and privacy. Your answer should include definitions of competition and market failures, and discussion of the market failures caused by information asymmetry (hint: adverse selection and moral hazard).

Solution

Ans

The policy will reduce price of insurance and improve insurance quality. The reason is due to ASSYMETRIC information two problems arise in insurance market. One is whom to give insurance. There are both good policy holders and bad policy holders. This is adverse selection problem.Quite often bad drivers apply more for policy. Thus insurance agencies don\'t approve policies even for good drivers. Other problem is once insurance has been approved, the drivers may involve themselves in rash driving because they don\'t have to bear much cost for it. Insurance company is liable for demages. Thus is moral hazard problem. Both these problems increase price of insurance and quality of insurance. Insurance agencies charge even higher amount to good drivers because they don\'t know who is good driver. They also do not provide exhaustive policies due to these two reasons because in case of accident then they will have to pay more.Thus there is market failure. They new policy reduces both these problems and thus corrects market failure. It will increase competition in market