law and economics of insurance final 100 hours

7/30/2019 Law and Economics of Insurance Final 100 Hours

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Law and Economics of

Insurance

Dr. G Bharathi Kamath,

Associate Professor,

College of Insurance, Insurance Institute of India


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Economics


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Introduction

What is economics?


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The Economic Way of Thinking


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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.


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At all levels

Micro- Households/Firm

Meso- Industry

Macro- Economy


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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.


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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


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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


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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


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Balancing the needs of the insured and the insurer


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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)


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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


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Definitions

Wealth- Adam smith

Welfare- Marshall

Scarcity- Robbins

Growth - Samuelson


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Significance

Consumption

Production

Exchange

Distribution


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Assumptions for economic laws

Rationality

Ceteris paribus

Optimization

Consumer

Producer


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Branches of Economics

Micro economics

Macro Economics


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Concept of Equilibrium

Static and dynamic

Stable and unstable

Short and long run

Partial and general


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The Mechanism of Choice

An economy is largely defined by how it answers

the WHAT, HOW and FOR WHOM questions


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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.


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The Invisible Hand of a Market

Economy

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

mechanism.


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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


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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


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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


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Economic Systems

Planned

Market

Mixed


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Concepts of Demand and Supply

Need , willingness, ability to buy and Demand

Stock and Supply


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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.


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Supply and Demand

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

a given time period, ceteris paribus.


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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


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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


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Law of Supply

Law of Supply

Supply Schedule and Curve


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Determinants of Demand

Price

Price of related products

Taste and preference of Consumers

Income levels of the consumer

Expectations about the future price

Demographic conditions

Fashion

Demonstration effect


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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


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Types of demand

Price

Income

Cross


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Law of demand

Demand schedule and curve


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Equilibrium of demand and supply

Shifts in demand and supply curves


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Elasticity of Demand

Meaning

Types of elasticity Price

Income Cross

Types of Price Elasticity Perfectly elastic

Perfectly inelastic Relatively elastic

Relatively inelastic

Unitary elastic


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Price Elasticity

The response of consumers to a change in price is

measured by the price elasticity of demand.


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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.


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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.


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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.


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Determinants of elasticity

Nature of the product

Variety of uses

Number of close substitutes

Durability of the commodity Proportion of income spent

Habits

Level and range of price change

Period of time

Possibility of postponement

Relation with other products


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Elasticity of Supply

Meaning

Types

Relatively elastic

Relatively inelastic Perfectly elastic

Perfectly inelastic


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Factors affecting elasticity

Cost of factors of production

Availability of factors of production

Time period

Technological advances

Government regulations


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Theory of Production and Analysis of

Costs

Concept of firm and industry

Factors of Production

Land

Labour Capital

Organization


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Types of costs

Money and real costs

Fixed and variable costs

Opportunity costs

Private and social costs

Short and long run costs


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Laws of Production

Law of diminishing Marginal returns

Law of returns to scale

Economies of scale


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Concept of Revenue

Meaning

Total revenue

Average revenue

Marginal revenue


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Break even Point

TR=TC


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Market Structure

Equilibrium of firm

Equating MC and MR


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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


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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

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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)

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Monopoly

Single firm

Produces & sells a particular good or service for

which there are no good substitutes

New firms are prevented from entering market

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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

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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

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Common Entry Barriers

Economies of scale

When long-run average cost declines over a

wide range of output relative to demand for the

product, there may not be room for another largeproducer to enter market

Barriers created by government

Licenses, exclusive franchises

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Input barriers

One firm controls a crucial input in the production

process

Brand loyaltiesStrong customer allegiance to existing firms may

keep new firms from finding enough buyers to

make entry worthwhile

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Consumer lock-inPotential entrants can be deterred if they believe

high switching costs will keep them from inducingmany consumers to change brands

Network externalities

Occur when value of a product increases asmore consumers buy & use it

Make it difficult for new firms to enter marketswhere firms have established a large network ofbuyers

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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

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Oligopoly Markets

Interdependence of firms profits

Distinguishing feature of oligopoly

Arises when number of firms in market is small enough

that every firms price & output decisions affect demand &

marginal revenue conditions of every other firm in market

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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

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Market demand for insurance

Price

Government regulations

Market structure

Nature of product (type of insurance)

Elasticity of demand for


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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


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Income elasticity of insurance

Level of economic activity and income levels

Life insurance

Personal lines of insurance

Property insurance


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Cross elasticity of insurance

Level and intensity of competition

Brand loyalty


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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


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Market structure of insurance

Number of competitors

Pricing

Product differentiation

Barriers to entry Economies of scale/market size

Capital requirements

Compulsory investments

FDI cap

Regulatory environment


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Insurance has to be SOLD rather than being

BOUGHT


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Thank You

Queries if any? Now or later

[email protected]
mailto:[email protected]:[email protected]

law and economics of insurance final 100 hours

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