ADVERSE SELECTION
Adverse selection is defined as when there is a lack of symmetric information which pre exists between a buyer and a seller that is when one party possesses information that the other party lacks. For example if we consider an insurance company when the person who requires an insurance hides pivotal information from the insurer that is considered as having asymmetric information. If the customer specifically mentions that he is a non smoker and does not consume alcohol he would get a better health insurance from the seller than compared to a smoker or an alcoholic. This would be beneficial to the consumer because he would have eligible to pay a lower premium. However the insurance company would be at a disadvantage because they would not have access to the correct information, that is the information which has been disclosed to them would be false and this would result in a loss to them.
Another example in relation to adverse selection is the selling of second hand cars. The buyer will not be aware about certain defects which the car may posses. However the seller of the car would know what is wrong with the car, that is, he would posses important information about the car but not disclose it to the buyer. The reason being that this would result in higher profits for the seller because he would keep the price of the vehicle the same irrespective of if there was a defect or not. This would be unfair to the consumer as he would be oblivious about this and thus in turn would be a paying a higher price for a good of bad quality.
CASE STUDY RELATING TO ADVERSE SELECTION
MAGGI
A year ago, the manufactures of Maggi, Nestle, was banned by the Government of India in the production of its very popular good. The reason being that Nestle had deliberately hid information about the content of its product. A particular ingredient of the product contained copious amount of lead, about 7.5 percent which is 4 percent higher than the legal limit. Thus by hiding this information not only did they violate the rules and regulation set forth by the government but also put all their consumers at a health risk. The problems did not end there, as Nestle was ordered to dispose of all their Maggi goods. Not only did this lead to an overallocation of resources but also negatively impacted the level of employment as Nestle were forced to shut down many of their branches. This further resulted in a loss in consumer loyalty and brand image of the company. A nestle chief executive, Suresh Narayan stated that his company has suffered a loss of 450 crores due to the fact that they hid this information.
METHODS TO REDUCE ADVERSE SELECTION
Implementing certain rules and regulations: The government could help many insurance companies by making it compulsory for customers who 'claim' to have no diseases or any health problems before getting insurance. Drug tests could also be carried out to try and find out if customers are actually telling the truth or not. Although this may not be a very practical solution it would certainly help insurance companies to find out who is telling the truth and who is not. The government can also charge different rates based on age or health so that the customers who are most at risk will pay higher premium costs
Fines- A consumer or producer found guilty of witholding valuable information about their product or themselves could be made to pay a fine by the government. Not only would this be fair to the party being affected but would also discourage other people from trying to do the same.
CITATIONS
Pettinger, Tejvan. "Adverse Selection Explained." Economics Help. N.p., 28 Nov. 2014. Web. 10 Jan. 2016.
Adverse selection is defined as when there is a lack of symmetric information which pre exists between a buyer and a seller that is when one party possesses information that the other party lacks. For example if we consider an insurance company when the person who requires an insurance hides pivotal information from the insurer that is considered as having asymmetric information. If the customer specifically mentions that he is a non smoker and does not consume alcohol he would get a better health insurance from the seller than compared to a smoker or an alcoholic. This would be beneficial to the consumer because he would have eligible to pay a lower premium. However the insurance company would be at a disadvantage because they would not have access to the correct information, that is the information which has been disclosed to them would be false and this would result in a loss to them.
Another example in relation to adverse selection is the selling of second hand cars. The buyer will not be aware about certain defects which the car may posses. However the seller of the car would know what is wrong with the car, that is, he would posses important information about the car but not disclose it to the buyer. The reason being that this would result in higher profits for the seller because he would keep the price of the vehicle the same irrespective of if there was a defect or not. This would be unfair to the consumer as he would be oblivious about this and thus in turn would be a paying a higher price for a good of bad quality.
CASE STUDY RELATING TO ADVERSE SELECTION
MAGGI
A year ago, the manufactures of Maggi, Nestle, was banned by the Government of India in the production of its very popular good. The reason being that Nestle had deliberately hid information about the content of its product. A particular ingredient of the product contained copious amount of lead, about 7.5 percent which is 4 percent higher than the legal limit. Thus by hiding this information not only did they violate the rules and regulation set forth by the government but also put all their consumers at a health risk. The problems did not end there, as Nestle was ordered to dispose of all their Maggi goods. Not only did this lead to an overallocation of resources but also negatively impacted the level of employment as Nestle were forced to shut down many of their branches. This further resulted in a loss in consumer loyalty and brand image of the company. A nestle chief executive, Suresh Narayan stated that his company has suffered a loss of 450 crores due to the fact that they hid this information.
METHODS TO REDUCE ADVERSE SELECTION
Implementing certain rules and regulations: The government could help many insurance companies by making it compulsory for customers who 'claim' to have no diseases or any health problems before getting insurance. Drug tests could also be carried out to try and find out if customers are actually telling the truth or not. Although this may not be a very practical solution it would certainly help insurance companies to find out who is telling the truth and who is not. The government can also charge different rates based on age or health so that the customers who are most at risk will pay higher premium costs
Fines- A consumer or producer found guilty of witholding valuable information about their product or themselves could be made to pay a fine by the government. Not only would this be fair to the party being affected but would also discourage other people from trying to do the same.
Pettinger, Tejvan. "Adverse Selection Explained." Economics Help. N.p., 28 Nov. 2014. Web. 10 Jan. 2016.
"Nestle Eyes Double Digit Growth for Maggi Noodles." - Moneycontrol.com. N.p., 27 Dec. 2015. Web. 10 Jan. 2016.
"Adverse Selection Examples - What Is Adverse Selection and How Can It Affect Your Projects?" Brighthub Project Management. N.p., n.d. Web. 10 Jan. 2016
No comments:
Post a Comment