Question

1.Provide at least two real-life examples of moral hazard. Your example can be related to either insurance industry or the financial market.

Answer 1

Moral hazard is a situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost. It arises when both the parties have incomplete information about each other. it is a conscious act.

example 1 - A's bike is not insured, he will take great care to avoid it getting stolen. He will lock it carefully. However, if it becomes insured for its full value then if it gets stolen he do not really lose out. Therefore, he have less incentive to protect against theft. This becomes a situation of asymmetric information. The insurance company may assume that he will look after his bike, but he actually wont.

example 2

Medical insurance companies may be reluctant to offer full insurance because doctors have an incentive to over-prescribe treatment – even if risky and not certain to work. Doctors will take on risky treatment because the cost is borne by insurance companies