Question

T/F/U. Used car salesmen use both moral hazard and adverse selection when trying to sell you a car. In your answer define both moral hazard and adverse selection in your own words and convey various situations where they are or are not used in this context.

Answer 1

Correct Answer:

U (uncertain)

Moral hazard is the phenomenon where people take decision while knowing that consequences of the decision will be faced by the others. Adverse selection refers to the scenario when there is an information asymmetry between the parties. A used car salesman may not necessarily involve moral hazard and adverse selection and it varies with the different sales man using in selling cars.

When a salesman hides the information related the used car from its customers and does not explain the risk that can be faced by the buyers. Then, adverse selection and moral hazard take place. But, when a sales man explains the every details of the car, then adverse selection is eliminated. Moral hazard is eliminated when risk part of the purchase is also discussed and judicious decision is made. It will let buyer to know the risk part and its consequences. So, it is uncertain for the used car salesmen.