Working Paper: NBER ID: w20411
Authors: Neale Mahoney; E. Glen Weyl
Abstract: Standard policies to correct market power and selection can be misguided when these two forces co-exist. Using a calibrated model of employer-sponsored health insurance, we show that the risk adjustment commonly used by employers to offset adverse selection often reduces the amount of high-quality coverage and thus social surplus. Conversely, in a model of subprime auto lending calibrated to Einav, Jenkins and Levin (2012), realistic levels of competition among lenders generate a significant oversupply of credit, implying greater market power is desirable. We build a model of symmetric imperfect competition in selection markets that parameterizes the degree of both market power and selection and use graphical price-theoretic reasoning to provide a general analysis of the interaction between selection and imperfect competition. We use the same logic to show that in selection markets four principles of the United States Horizontal Merger Guidelines are often reversed.
Keywords: selection markets; market power; risk adjustment; health insurance; consumer lending
JEL Codes: D42; D43; D82; I13; L10; L41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| risk adjustment (G52) | higher prices (D49) |
| risk adjustment (G52) | reduced social surplus (D69) |
| market power (L11) | worsened adverse selection (D82) |
| increased competition among lenders (G21) | oversupply of credit (E51) |
| oversupply of credit (E51) | socially wasteful outcomes (D63) |
| lenders lowering down payment requirements (G21) | attracting high-risk marginal borrowers (G21) |
| advantageous selection (C52) | excessive competition (L13) |
| mergers (G34) | beneficial in selection markets (D47) |