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1.2 Individual economic decision making (A-level only)

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Question 10

An insurance provider faces two distinct market failures arising from asymmetric information:

  • Situation 1: Individuals with a high risk of chronic illness are disproportionately more likely to purchase comprehensive healthcare plans, while healthy individuals opt out.
  • Situation 2: Once insured, policyholders tend to adopt less healthy lifestyles and skip routine preventative check-ups because their treatment costs are fully covered.

To combat these, the provider introduces Policy A (requiring a comprehensive medical history report and examination before a policy is issued) and Policy B (introducing a £250 excess/co-payment for every medical claim).

Which of the following correctly pairs the situations with their corresponding market failure and the policy designed to mitigate them?

Situation 1 is adverse selection, addressed by Policy A (screening); Situation 2 is moral hazard, addressed by Policy B (incentive alignment).

Situation 1 is moral hazard, addressed by Policy A (signalling); Situation 2 is adverse selection, addressed by Policy B (incentive alignment).

Situation 1 is adverse selection, addressed by Policy B (incentive alignment); Situation 2 is moral hazard, addressed by Policy A (screening).

Situation 1 is moral hazard, addressed by Policy B (screening); Situation 2 is adverse selection, addressed by Policy A (signalling).

1.2 Individual economic decision making (A-level only) Questions

  1. A Level
  2. /Economics
  3. /1.2 Individual economic decision making (A-level only)