Question

Define and explain the importance of all of the following concepts.

1. Adverse Selection

2. Moral Hazard

3. Too Big To Fail Problem

Answer 1

Adverse selection -

This problem occurs before transaction between the two parties.

when one party has more information than another or can say that either buyers or sellers have information that the other group does not have .

For example - used cars , seller of a used car has more information than the buyers .

Important-

Study of problem of adverse selection is important because than one party having more information can charge different prices according to different people .

Like high from high risk people etc.

Moral hazard -

It occurs after the transaction has occured ,when a party has incentive to engage in risky activities .

For example people become less carefully when they have health insurance ,or vehicle insurance etc.

Importance

This problems helps to access the behavior of parties and need to take proper monitoring of parties and policies to prevent immoral behavior.

3) Too Big To Fail Problem

This phrase was used by W Bush's administration during financial crisis 2008

From too big , it doesn't means the size of a business or industry but the to the extent it is intermingled with other sectors and it's impact on all the sectors or economy if it fails.

For example - Big Banks in US during financial crisis b- if they fails then whole banking system and economy of US as well as world would have impacted

Importance -

This concept tells the need to save the too big business which could have impact everyone .