Question

A-What characteristics are common between Adverse Selection and Moral Hazard?

B. Explain the general argument behind moral hazard.

C. How does the price elasticity of demand influence the moral hazard problem?

D. Explain how an insurer could reduce the scope of the moral hazard problem by introducing a consumer copayment.

Answer 1

A. Moral hazard and adverse selection both occur at the time of asymmetric information between both the parties, but whenever there is any change detected in the behavior of any of the party after the deal is struck. If there is any change in the behavior of any of the parties included in the deal then the asymmetric information occurs which results in occurrence of adverse selection as well as moral hazard.

B. Moral hazard is a situation where one party gets involved in an event which is risky in nature and the other party involved in such an event will bear the cost. Such a situation arises when both parties have an incomplete information and details about each other. The arguments arising behind the moral hazard is that it could not have played the role of a financial crisis for mere catastrophic failure, the non acceptance of it by the big banks and negative externalities from corporate governance.

C. The price elasticity of demand influences the moral hazard problem, as the coat of the event borne by one party is enacted by another party. In such a situation the change in price elasticity of the event will influence the moral hazard problem too.  

D. It shows long-lasting cost savings from the higher consumer copayments. The existence of moral hazard, implies more cost sharing which reduces demand for such activities. The consumer copayment results in cost savings which affects the moral hazard and the insurer can reduce the scope of it.