Posted: September 13th, 2017

“Soft Selling” and Adverse Selection / Auto Insurance

“Soft Selling” and Adverse Selection / Auto Insurance

– Please label each answer Q1, Q2, etc.
– Please provide 1 APA citation per response

Q1
“Soft Selling” and Adverse Selection / Auto Insurance
Soft selling occurs when a buyer is skeptical of the quality or usefulness of a product or service.  For example, suppose you’re trying to sell a company a new accounting system that will reduce costs by 10%.  Instead of asking for a price, you offer to give them the product in exchange for 50% of their cost savings.  Describe the information asymmetry, the adverse selection problem, and why soft selling is a successful signal.

Q2
Auto Insurance
Suppose that every driver faces a 1% probability of an automobile accident every year. An accident will, on average, cost each driver $10,000. Suppose there are two types of individuals: those with $60,000 in the bank and those with $5,000 in the bank. Assume that individuals with $5,000 in the bank declare bankruptcy if they get in an accident. In bankruptcy, creditors receive only what individuals have in the bank. What is the actuarially fair price of insurance? What price are individuals with $5,000 in the bank willing to pay for the insurance? Will those with $5,000 in the bank voluntarily purchase insurance? [Hint: Remember that there are state laws forcing individuals to purchase auto liability insurance.]