Question

A researcher may have difficulty separating moral hazard from adverse selection. Use an example to show why this may be the case.

Answer 1

Though there are lots of difference in between moral hazard and adverse selection but sometimes researcher find it difficult to seperate them. This can be explained with an example like if we want to sell the product or the firm to the new owner , you can see this is an obvious example of involving both adverse selection and moral hazard as new ownee may not run the firm with then intensity .He may not be able work with full efficiency and efforts. The prescription of optimal sales contract depends upon adverse selection and moral hazard which seems difficult to seperate them from one another.

The difficulty in recognising both can occur because the moral hazard occurs after the contract was entered and adverse selection occurs before entering the contract. Both the events cause the loss to one party . There is only the difference as to when these take place. This makes it difficult to differentiate.