[MUSIC] In this example, we can see that only the adverse risk, the bad risk, the sick people choose to purchase health insurance and the good risk, the healthy, stay out of the market. And the market collapses. So how can we step in and fix this market? Somehow we have to make sure that these healthy people go ahead and they, too, decide to purchase insurance. There are a couple of mechanisms we can do this. One mechanism is to offer the policy to a population as a whole, not to offer the policy at an individual basis but at a population basis. Here in America, health insurance is often tied to the workplace. And one motivation for that is that in the workplace we have a mix of healthy and sick people, so that we don't have this adverse selection. We don't have only sick people purchasing health insurance because everyone that works for the firm has to purchase the health insurance together. Another option is to have a mandate, to tell the healthy people, you have to buy health insurance. You don't have a choice. One way of doing that is maybe punishing the healthy if they don't buy health insurance. In this numerical example, we would have to put a penalty in place that would make the healthy person indifferent between buying health insurance and not buying health insurance. How big would this penalty have to be? Well, if the cost of health insurance is $2,000, and if the healthy person expects to get $1,000 back, the penalty has to equal the difference between the two. 2,000-1,000, the penalty would have to be $1,000. In that case, the healthy person says, either way I'm losing $1,000. I might as well lose the $1,000 and purchase the health insurance. So these are two mechanism of getting around this issue of adverse selection.