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The economics of flood insurance
The economics of flood insurance

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3.5 Market failure and buying on flood plains

In addition to a market failure in the supply-side of the market for homes on flood plains, there may also be a failure on the demand-side.

Homebuyers coming to this market, may either have full information and be making rational decisions to buy a home on a flood plain for the variety of reasons you considered in Section 2.2 or they may be making decisions based on imperfect information. That may be for a variety of reasons, for example: because the information is unavailable; it is too costly to obtain; it is available but buyers are unaware of it; or they have the information but are unable to process it accurately. There may be a situation of asymmetric information in the market, with the buyers alone unable to appreciate the ultimate potential costs to them of the flood risk. The demand-and-supply model can help to demonstrate how asymmetry distorts the demand for housing, causing more high flood-risk homes to be bought than the socially optimal amount, as shown in the slideshow in Figure 10.

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Figure 10 Modelling the impact of asymmetric information on buying on a flood plain
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