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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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Common Entry Barriers
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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Common Entry Barriers
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
62
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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
mailto:[email protected]:[email protected]