Greg Delemeester uses a blog to post an Econ Bonus Question of the Week for his classes. You need to be one of his students to get the extra points for answering but that doesn't mean the rest of us can't benefit from the great questions he comes up with. Since I've just finished covering asymmetric information in my Principles class, I'll be posting a link for my students to his most recent post which asks:
Suppose that a company offers "grade insurance" that works as follows: For each course in which you get a grade below a C, the insurance company pays you $500. Before offering the insurance policy for sale, the insurance company looks over the transcripts of university students and finds that on average 10% of all grades are below a C. Explain why the insurance company would be incorrect in assuming that it would only have to pay claims on about 10% of its policies. What is the implication of your analysis for the optimal premium (i.e., price) the company should charge its customers?