Identify each of the following as an adverse selection or a moral hazard problem: Instructions: In...

Identify each of the following as an adverse selection or a moral hazard problem:

Instructions: In each case, very briefly (one sentence or two) state the reason for your choice.

a) A person with car insurance fails to lock his car doors when he shops at a mall.

b) A person with family history of cancer purchases the most complete health coverage available.

c) A person with health insurance takes more risks on the ski slopes of Aspen than he would without health insurance.

d) A college professor receives tenure (assurance of permanent employment) from her employer.

e) A patient pays his surgeon before she performs the surgery.

Solutions

Expert Solution

Adverse selection is a phenomenon, in which the parties on one side of the market, who have information, which is unknown to others, select in some way that adversely, affects the parties on the other side of the market. When buyers or sellers have asymmetric information, bad products or services are most likely to be selected. Moral hazard is a condition that exists when one party in the transaction changes his or her behavior in a way that is costly and hidden to another party.

1. This is an example of moral hazard. A person with car insurance fails to lock his car doors because the cost is not so high, as it would have been without insurance.

2. This is an adverse selection problem. When a person with a family history of cancer purchases complete health coverage, this information is unknown to the insurance company. There is a risk for the insurance company of adversely selecting against cancer.

3. This is a moral hazard problem. A person with health insurance takes more risks, as the cost is not so high, as it would have been without insurance.

4. This is a moral hazard problem. The college is taking the risk, as once the professor is given a permanent offer, she cannot be easily removed from work. The cost to college is not so high as compared to the risk of having no professor.

5. This is a moral hazard problem. A patient has to pay to the doctor for the treatment. The patient takes a risk, as this is low as compared to the cost incurred with surgery.

Rahul Sunny answered 1 year ago

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