law and economics of insurance

7/31/2019 Law and Economics of Insurance

1/70

Law and Economics of

Insurance

Dr. Bharathi Kamath


2/70

Economics


3/70

Introduction

What is economics?


4/70

The Economic Way of Thinking


5/70

The Economic Problem

Economicsis the study of how best to allocatescarce resources among competing uses.

Scarcityis the lack of enough resources to satisfy

all desired uses of those resources.


6/70

At all levels

Micro- Households/Firm

Meso- Industry

Macro- Economy


7/70

Three core issues must be resolved:

WHATto produce with our limited resources.

HOWto produce the goods and services weselect.

FOR WHOMgoods and services are produced;that is, who should get them.


8/70

Role of economics in economic

activity

Insurance as an important part of economic activity

Mobilization of savings

Investment

Economic growth and development

Increase in productivity


9/70

Risks and uncertainty

Future is uncertain and involves several risks

Risk is actuarial probability that can be calculated

in advance

whereas uncertainty is accidental and thereforecannot be calculated on the grounds of historical

facts or empirical conclusions


10/70

Types of risks

Dynamic Demand and supply

Changes in consumer preferences

Technological changes Innovation

Regulations

Market speculation

Competitors suppliers

Pure/static Loss arising of static risk- quantifiable and measurable


11/70

Balancing the needs of the insured and the insurer


12/70

Law of diminishing marginal utility

Law of equi-marginal utility

Marginal utility of money and insurance

Present sacrifice of money income (present loss of

utility/certain loss)

future loss of income due to occurrence of an event(expected loss of utility/expected loss)


13/70

Benefits of Insurance activity

Ensures efficiency and productivity in economicstructure(insured has to concentrate on speculativerisks only)

The need for liquid assets and contingency reserve

decreases

Capital resources can be mobilized to more productiveuse

Reduction in the cost of handling risk benefits the

society as a whole Channelizing the investment in the economy by the

insurers

Social security and welfare


14/70

Definitions

Wealth- Adam smith

Welfare- Marshall

Scarcity- Robbins

Growth - Samuelson


15/70

Significance

Consumption

Production

Exchange

Distribution


16/70

Assumptions for economic laws

Rationality

Ceteris paribus

Optimization

Consumer

Producer


17/70

Branches of Economics

Micro economics

Macro Economics


18/70

Concept of Equilibrium

Static and dynamic

Stable and unstable

Short and long run

Partial and general


19/70

The Mechanism of Choice

An economy is largely defined by how it answers

the WHAT, HOW and FOR WHOM questions


20/70

The Invisible Hand of a Market

Economy

The market mechanismis the use of marketprices and sales to signal desired outputs (or

resource allocations).

The market decides the mix of output in aneconomy.


21/70

The Invisible Hand of a Market

Economy

Laissez faireis the doctrine ofleave it alone ofnonintervention by government in the market

mechanism.


22/70

Government Intervention and

Command Economies

Karl Marx argued that the government not only had

to intervene but had to own all the means of

production.

Markets permit capitalists to enrich themselveswhile the proletariat toil long hours for subsistence

wages


23/70

Government Intervention and

Command Economies

John Maynard Keynes offered a less drastic

solution

In Keynes view, government should play an active

but not an all-inclusive role in managing theeconomy


24/70

Mixed economy

A mixed economyis one that uses both marketsignals and government directives to allocate

goods and resources.

Most economies use a combination of marketsignals and government directives to select

economic outcomes


25/70

Economic Systems

Planned

Market

Mixed


26/70

Concepts of Demand and Supply

Need , willingness, ability to buy and Demand

Stock and Supply


27/70

Supply and Demand

Supplyis the ability and willingness to sell(produce) specific quantities of a good at

alternative prices in a given time period, ceteris

paribus.


28/70

Supply and Demand

Demandis the ability and willingness to buyspecific quantities of a good at alternative prices in

a given time period, ceteris paribus.


29/70

Determinants of Supply

Price

Cost of Production

Techniques of production

Taxation

Natural factors

Price of related products

Price of Factors of Production

Expectations about future price


30/70

Generalized Supply FunctionVariable Relation to Qs Sign of Slope Parameter

P

Pe

F

PI

Pr

Direct

Direct

Direct

Inverse

Inverse

Inverse for substitutes

k = Qs/ P is positive

l = Qs

/ PI

is negative

m = Qs/ Pr is negative

m = Qs/ Pr is positive

r = Qs/ Pe is negative

s = Qs/ F is positive

Direct for complements

n = Qs/ T is positiveT


31/70

Law of Supply

Law of Supply

Supply Schedule and Curve


32/70


33/70

Generalized Demand

Function

Inverse for complements

Variable Relation to Qd Sign of Slope Parameter

P

Pe

N

M

PR

Inverse

Direct

Direct

Direct

Direct for normal goods

Inverse for inferior goods

Direct for substitutes

b = Qd/ P is negative

c = Qd/ M is positive

c = Qd/ M is negative

d = Qd/ PR is positive

d = Qd/ PR is negative

f = Qd/ Pe is positive

g = Qd/ N is positive

e = Qd/ is positive


34/70

Types of demand

Price

Income

Cross


35/70

Law of demand

Demand schedule and curve


36/70

Equilibrium of demand and supply

Shifts in demand and supply curves


37/70


38/70

Price Elasticity

The response of consumers to a change in price is

measured by the price elasticity of demand.


39/70

Price Elasticity

The price elasticity of demand (E) is alwaysnegative because quantity demanded decreases

when prices increase.

The absolute value of the price elasticity of

demand will always be greater than zero.


40/70

Elastic vs. Inelastic Demand

IfEis larger than 1, demand is elastic. Consumer response is large relative to the change in

price.

IfEis less than 1, demand is called inelastic. Consumers arent very responsive to price changes.

IfEequals 1, demand is unitary elastic.


41/70

Extremes of Elasticity

A horizontal demand curve means that demand is

perfectly elastic.

Any price increase would cause demand to fall to zero.

A vertical demand curve means that demand iscompletely inelastic.

Quantity demanded will not change regardless of the

price change.


42/70


43/70

Elasticity of Supply

Meaning

Types

Relatively elastic

Relatively inelastic Perfectly elastic

Perfectly inelastic


44/70

Factors affecting elasticity

Cost of factors of production

Availability of factors of production

Time period

Technological advances

Government regulations


45/70


46/70


47/70

Laws of Production

Law of diminishing Marginal returns

Law of returns to scale

Economies of scale


48/70

Concept of Revenue

Meaning

Total revenue

Average revenue

Marginal revenue


49/70


50/70

Market Structure

Equilibrium of firm

Equating MC and MR


51/70

Types of Market Structures

Perfect market-characteristics

Large number of buyers and sellers

Homogenous products

Free entry and exit Perfect knowledge

Mobility of factors of production

No transportation costs

No government interference

AR and MR curve in a perfectly competitive market


52/70

Demand for a Competitive

Price-Taker

Demand curve is horizontal at price determined by

intersection of market demand & supply

Perfectly elastic

Marginal revenue equals price Demand curve is also marginal revenue curve (D =

MR)

Can sell all they want at the market price

Each additional unit of sales adds to total revenue an

amount equal to price, i.e. MR=AR=P

52


53/70

Market Power

Ability of a firm to raise price without losing all its

sales

Any firm that faces downward sloping demand has

market power

Gives firm ability to raise price above average cost

& earn economic profit (if demand & cost

conditions permit)

53


54/70

Monopoly

Single firm

Produces & sells a particular good or service for

which there are no good substitutes

New firms are prevented from entering market

54


55/70

Measurement of Market

Power

Degree of market power inversely related to

price elasticity of demand

The less elastic the firms demand, the greater its

degree of market power The fewer close substitutes for a firms product, the

smaller the elasticity of demand (in absolute value) &

the greater the firms market power

When demand is perfectly elastic (demand ishorizontal), the firm has no market power

55


56/70

Determinants of Market

Power

Entry of new firms into a market erodesmarket power of existing firms by increasingthe number of substitutes

A firm can possess a high degree of marketpower only when strong barriers to entryexist Conditions that make it difficult for new firms to enter a

market in which economic profits are being earned

56


57/70


58/70


59/70


60/70

Monopolistic Competition

Large number of firms sell a differentiatedproduct Products are close (not perfect) substitutes

Market is monopolistic Product differentiation creates a degree of market

power

Market is competitive Large number of firms, easy entry

60


61/70


62/70

Strategic Decisions

Strategic behavior

Actions taken by firms to plan for & react to competition

from rival firms

Game theory Useful guidelines on behavior for strategic situations

involving interdependence

62


63/70

Market demand for insurance

Price

Government regulations

Market structure

Nature of product (type of insurance)

Elasticity of demand for


64/70

Elasticity of demand for

insurance

Market demand is relatively inelastic than

individual demand

Availability of substitutes

Price of the product(premium) Mandatory (inelastic demand)

Income levels

Product differentiation and brand loyalty Individuals demand inelastic when compared to

business and industrial establishments


65/70

Income elasticity of insurance

Level of economic activity and income levels

Life insurance

Personal lines of insurance

Property insurance


66/70

Cross elasticity of insurance

Level and intensity of competition

Brand loyalty


67/70

Supply of Insurance

Labour intensive industry

Low level of fixed costs; high level of variable costs

Break even point (TR=TC)

Supply depends on the number of players

Government regulations regarding pricing


68/70


69/70


70/70

law and economics of insurance

Documents