Question

Below is an excerpt of the abstract of a recent journal article entitled “Do social connections reduce moral hazard? Evidence from the New York City taxi industry” by C. Kirabo Jackson and Henry Schneider (2011):

We investigate the role of social networks in aligning the incentives of agents in settings with incomplete contracts. We study the New York City taxi industry where taxis are often leased and lessee-drivers have worse driving outcomes [like gas overuse and accidents] than owner-drivers due to a moral hazard associated with incomplete contracts. We find that ... drivers leasing from members of their country-of-birth community exhibit significantly reduced effects of moral hazard ...

Draw an analogy between health insurance and taxi leasing in terms of moral hazard. In each case, highlight the price distortion, the behavior change due to price sensitivity, the information asymmetry, and the outcome of the moral hazard.

Answer 1

1. Moral hazard is a condition where one party which is protected against risk involves in a risky event, while the other party which is not protected incurs the cost.

2. There is a situation called Adverse selection where it's a liability to those people who involve in dangerous jobs in order to get insurance.

3. But in terms of moral hazard, it arises where both parties don't have complete information on each other. But in terms of adverse selection, it arises when sellers have the required information where the other party don't or vice versa.

4. These factors affect health insurance markets as there would be tendency to increase prices for certain aged group if they know that they have certain factors to get or involved in accidents.

5. And in the other point of view, they might pick other certain aged group people who generally don't get or involved in accidents and lemon drop those to those who get into accidents. So these factors don't provide optimal amount of insurance of car/taxi at an efficient and effective price.