Intervention Measures (Adverse Selection)

Two ways to counter adverse selection

• Screening

• Signalling

• Laws & Regulations —- Lemons Law

Define Screening

To counter adverse selection & gather more information to make the right decision.

Process of Screening → Reduced AS

Second hand cars market:

• Screen: Bring used cars for inspection and checking records

  • Better information on car quality → reduced AS

Health Insurance:

• Screen: Detailed questionnaires or medical check-ups

  • Assesses risk → reflects true private cost/benefit → set premiums accordingly

Better matching of prices to risk/quality → prevent missing markets of good quality cars/low-risk individuals → improve price signals → eliminate DWL → resolve MF

Limitations of screening

• Feasibility: Time consuming, costly and raises questions on privacy

  • Not feasible for smaller businesses or resource limited individuals

• Effectiveness: Screening is imperfect; missing & inaccurate information can lead flaws in risk assessments → adverse selection persists

Define Signalling

The seller’s attempt to reveal credible information about what they have to sell in order to make themselves more attractive to buyers → reducing adverse selection

Process of Signaling → Reduced Adverse Selection (AS)

• Sellers signal product quality: through warranties, guarantees and certifications

  • E.g. SAFETY mark on applicances, Nutri-grade level etc

• Acts as credible signals, since poor quality sellers are less likely to offer them due to repair/refund costs.

• Buyers more willing & able to pay

  • Incentivizes good quality sellers to stay in the market

  • Reduces overconsumption of lemons

• Promotes allocative efficiency —> eliminate DWL —> MF solved

Limitations of signalling

• Increase costs for firms engaging in signalling

• Only effective if signals are credible: High quality & low quality sellers cannot share the same signals → fail to clear AS

Define how laws & regulations (lemon laws) can reduce AS

Limit ability of informed parties to exploit hidden information

Process of using Lemon Laws to counter AS

• E.g. CPFTA: protects buyers from defective goods

  • If defects are present within 6 months of delivery, it is assumed to present at delivery unless proven otherwise

• Discourage sellers from misrepresenting poor quality goods

  • Incentivizes sale of high quality goods

• Boost consumer confidence despite info gap

  • Encourage fair trade, improve price signals

• Reduce overconsumption of lemons → improve AE → reduce DWL → MF resolved

Limitations of Lemon Laws

Discourage foreign manufacturers from entering SG’s small market, limiting product variety for consumers → fall in CS and consumer welfare

How do we counter moral hazard?

Copayments

Define co-payments

Fixed amount paid by the insured for each service; insurer covers the remaining costs

Process of co-payments addressing moral hazard

• Forces insured consumers to share part of the cost

  • Deductible: Down-payment the insured must pay for the insurance coverage to begin

• Creates financial stake in their decisions

  • Loss aversion: Reduce risk taking behaviors that may lead to additional out-of-pocket costs

• Reduces overconsumption of claims

  • Imporves allocative efficiency → reduce DWL → resolve MF

Limitations of copayments

• Viewed as sunk cost: lead to over-consumption of healthcare after paying → increase DWL

• Inequity: Imposes financial burden on those with chronic illnesses/low income individuals → limit access to essential healthcare → inequity