The Value of Car Insurance

This activity could be used in an ambitious introductory microeconomics course, but is probably more appropriate as an activity for intermediate microeconomics students before they start formal modeling of insurance. Students should be familiar with basic consumer choice models (i.e., utility maximization) and may have seen expected utility models. Each of the two stages of the activity should take about 10 minutes.

Overview

Teams are placed in a hypothetical situation where they have to decide whether to insure a car or not. They are given a couple factors that should affect their decision and must come up with several more. In the second part of the exercise, the instructor compiles a large list and teams choose from that list which they think matters the most (e.g., price of insurance) and which matters the least (price of the car which is a sunk cost).

Expected Student Learning Outcomes

Identify the factors involved in consumer demand for insurance.

Information Given to Students

Part 1:

Right before the semester starts, you find an amazing deal on a used car and purchase it. Soon after you realize that if you want to drive it legally, you are going to have to purchase insurance. You don't have time to sell the car to someone else, and now you have to decide whether to purchase insurance for it or let it sit idle until the semester ends.

List as many factors as you can think of that will play a part in your decision process. Price of insurance should be first on your list, but what else matters?

Part 2:

Now that we have a big list of factors, which do you think is the most important? Least important?

Part 3:

Now that we have considered the importance of the different factors, what decision would you make?

A) Buy insurance

B) Not buy insurance and let the car sit idle

doug-ae-5-student-handout.docx (Microsoft Word 2007 (.docx) 12kB Mar7 20)

This activity works well as kick-off activity for a unit on insurance. It gets students thinking about the decision process and provides a concrete example that can be used later when you present the expected utility model.

After Part 1, the instructor should compile a long list of factors by merging and discussing the suggestions of the different groups. These can be categorized along the way and you should get a list that looks something like this:

Factors related to the car insurance itself:
- Price of insurance
- Deductible
- Maximum payout
- Reputability of the insurance company

Factors related to the preferences/budget of the individual:
- Risk aversion
- Income/wealth
- Recreational value of driving
- Value of driving to and from campus

Factors related to danger of driving in the area:
- How many miles per day would you drive
- How dangerous are the roads this time of year
- Availability of public transportation
- How good a driver is the individual

Once the instructor and the class have a good list, the instructor should pick 4 and label them A through D and then add a choice E: the price of the car. This is the choice set for Part 2.

The instructor should expect students to say the price of the car is the least important factor as it is a sunk cost. There are no obvious right or wrong answers here, but ranking the factors should spur an interesting discussion.

Part 3 will be fun for students as they have to decide what they would do. Some students may argue that they would like to drive the car illegally without insurance. This could spark an interesting discussion about how we should factor in the probability of getting caught and the consequences of getting caught.

At the end, the instructor should emphasize the fact that we will be modeling this decision formally and will try to incorporate the most important factors in our mathematical models.

This exercise prepares students for learning the nuts and bolts of expected utility and insurance later on.