Equilibrium in Competitive Insurance Markets: The Welfare Economics of Moral Hazard
This paper examines the existence and properties of competitive equilibrium in economies with moral hazard. The nature of competitive equilibrium depends on whether insurers can observe an insured's total purchases of insurance. If insurers can observe this, an individual will purchase all his insurance from a single agent, and the contract will specify the price but also ration the quantity. If insurers cannot observe this, then a competitive equilibrium may not exist. Equilibrium may be characterized by random insurance.
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