Imperfect Competition in Selection Markets
54 Pages Posted: 30 Dec 2013 Last revised: 12 Jul 2016
Date Written: June 8, 2016
Policies to correct market power and selection can be misguided when these forces co-exist. We build a model of symmetric imperfect competition in selection markets that parameterizes the degree of market power and selection. We use graphical price-theoretic reasoning to characterize the interaction between these forces. Using a calibrated model of health insurance, we show that the risk adjustment commonly used to offset adverse selection can reduce the amount of coverage and social surplus. Conversely, in a calibrated model of subprime auto lending, realistic levels of competition can generate an oversupply of credit, implying greater market power is desirable.
Keywords: selection market, imperfect competition, mergers, risk adjustment, risk-based pricing
JEL Classification: D42, D43, D82, I13, L10, L41
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