“In economics, moral hazard occurs when an individual has an incentive to increase their exposure to...

“In economics, moral hazard occurs when an individual has an incentive to increase their exposure to risk because they do not bear the full costs of that risk. For example, when a person is insured, they may take on higher risk knowing that their insurance will pay the associated costs.”

One of the topics of chapter 10 is market power and concentration. In the current economic crisis, many large firms will receive governments “bailouts.” What is your opinion of the possibility that government “bailouts” will only increase moral hazard of large firms that are “too big to fail.”

Solutions

Expert Solution

Moral Hazard is a critical concept of economics. It clearly defines the fact that irrational behaviour may take place and a person may be able to take larger risks, if they believe that the risk would not affect their actions. The example of insurance here is correct. So long as a person has car insurance, they are less worried if their car is damaged because they are aware that major part of the costs is covered.

Similarly, in the current environment as the COVID 19 has created greater issues for the private sectors, a bailout package by the government may make them continue with reckless activities such as production of those goods and services which may not be needed. Or to continue pursuing certain costs which are avoidable and should not be allowed for a firm’s profit. For example, it is said that corporations use expenses as a technique to evade taxation. Therefore, if the government was not to give such bailout packages, companies would be forced to reduce some of the unnecessary expenditure.

Thus, we find evidence in the fact that the bailout package may lead to a critical moral hazard of companies becoming complacent and irresponsible towards their expenses as they would know that governments would help them in paying off a large portion of the added expenses. Some may also seek loans at lower interest rates and this may increase bad debts for the society at large.

Please feel free to ask your doubts in the comments section.

Rahul Sunny answered 2 weeks ago

Next > < Previous

Related Solutions

10. What are the moral hazard and adverse selection when the borrower is a national government?...

10. What are the moral hazard and adverse selection when the borrower is a national government? • Give one example of the adverse selection and the moral hazard behavior. • Use an example of a country whose government defaulted (=refused to pay) on its national debt

How does the “too big to fail” increase moral hazard? Can you cite an example from...

How does the “too big to fail” increase moral hazard? Can you cite an example from the 2007- 2009 financial crisis?

When do insurance companies encounter the problem of moral hazard? When simply having insurance causes people...

When do insurance companies encounter the problem of moral hazard? When simply having insurance causes people to take more risks than they would otherwise. When they do not have enough information to distinguish between people who are "good risks" and those who are "bad risks." When the price of insurance premiums fully reflects all available information. When the insurance company suffers large losses because a major catastrophe has affected a large number of people simultaneously.

Market failure occurs when no individual has the ability to substantially influence market prices. a. True...

Market failure occurs when no individual has the ability to substantially influence market prices. a. True b. False

Explain why the Health Insurance or Car Insurance Industry has a Moral Hazard problem?

QUESTION 37 Because of the problems of adverse selection and moral hazard, it has been suggested...

QUESTION 37 Because of the problems of adverse selection and moral hazard, it has been suggested that the World Bank and International Monetary Fund make loans to the riskiest nations so that private investors will not be tempted to take a risk. not make loans to risky nations because there is a high demand for funds from safer nations. loan only to countries that have free elections. impose tougher preconditions on borrowers. QUESTION 38 The three sources of private direct...

Evaluate the following statements: “Moral hazard behavior decreases when the price elasticity of demand increases.” “Managed...

Evaluate the following statements: “Moral hazard behavior decreases when the price elasticity of demand increases.” “Managed care creates incentives that improve the principal-agent relationship.” “Adverse selection and favorable/preferred selection make health insurance more affordable.”

The Bombay phenotype occurs when an individual human is homozygous for a recessive allele at the...

The Bombay phenotype occurs when an individual human is homozygous for a recessive allele at the FUT1 locus. Individuals with this genotype do not make a precursor substance required to synthesize the A and B antigens that sometimes appear on human red blood cells. Regardless of their genotype at the ABO blood type locus, individuals who are homozygous for the Bombay phenotype allele at the FUT1 locus will appear to have blood type O on standard blood type tests. Note:...

1) Economic growth occurs when there is an increase in the inflation rate. there is a...

1) Economic growth occurs when there is an increase in the inflation rate. there is a decrease in the unemployment rate. we discover a sleeping worker who is forced to go back to work. there is an increase in the amount of capital. 2) Saving is important for economic growth because it increases investment spending. because we increase our consumption immediately. because it reduces investment spending. because our standard of living will decrease. 3) The circular flow of income shows...

it has been asserted that moral hazard may lead to wage differences in relatively similar labor...

it has been asserted that moral hazard may lead to wage differences in relatively similar labor markets. If your organization or other organization you knew faces moral hazard, what do you think the solution would be to minimize the effect of wage inequality? What kind of lessons or information should the company you chose obtain from the labor market to deal with this problem? How do you think the existence of wage differentials affect employees, the organization you identified, and...

Subjects