cars, lawyers, and everything else they buy. Employers and lenders cannot be perfectly omniscient about

whether possible workers will turn out well or potential borrowers will repay loans on time. However, the

mechanisms that we mentioned above can reduce the risks associated with imperfect information so that the

buyer and seller are willing to proceed.
394 16 • Information, Risk, and Insurance

16.2 Insurance and Imperfect Information

LEARNING OBJECTIVES

By the end of this section, you will be able to:

• Explain how insurance works

•

Identify and evaluate various forms of government and social insurance

• Discuss the problems caused by moral hazard and adverse selection

• Analyze the impact of government regulation of insurance

Insurance is a method that households and firms use to prevent any single event from having a significant

detrimental financial effect. Generally, households or firms with insurance make regular payments, called
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