Question

Which of the following scenarios best illustrates adverse selection? Select one:

a. Individuals changing their effort level after signing a fully-guaranteed contract
b. Individuals who have existing medical conditions (but not physically apparent) decide to take up health insurance
c. Individuals engaging in more risky behavior after receiving medical insurance
d. Individuals changing their financial behavior or activity after receiving a loan

Answer 1

The best scenario that illustrates adverse selection is option b, where individuals who have existing medical conditions but are not physically apparent, decide to take up health insurance.

Step-by-step explanation:

The best scenario that illustrates adverse selection is option b, where individuals who have existing medical conditions but are not physically apparent, decide to take up health insurance. Adverse selection occurs when riskier individuals buy insurance while less risky individuals do not. If only sick(er) people buy insurance, the cost of insurance becomes extremely expensive. This is a common problem in insurance markets, where buyers have more information about their risk levels than the insurance company.