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Homework answers / question archive / True or False: Suppose that you sell bicycle theft insurance and bicycle owners do not know whether they are high- or low-risk consumers
True or False: Suppose that you sell bicycle theft insurance and bicycle owners do not know whether they are high- or low-risk consumers. This situation causes an adverse selection problem, but only if the person is a high-risk consumer.
False
Adverse selection in the above case will be when the owners of the bicycle avail insurance of a higher amount than the risk to the bicycle. If there is a risk of loss to the bicycle is high than the cost of insurance paid by the owner then, there will nil adverse selection in the market. On the other side, the probability of occurrence of negative externality thorough adverse selection is more when the risk of damage to the bicycle is less.
