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Microeconomics

13th Edition
Roger A. Arnold
ISBN: 9781337617406

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Microeconomics

13th Edition
Roger A. Arnold
ISBN: 9781337617406
Textbook Problem

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

  1. a. A person with car insurance fails to lock his car doors when he shops at a mall.
  2. b. A person with a family history of cancer purchases the most complete health coverage available.
  3. c. A person with health insurance takes more risks on the ski slopes of Aspen than he would without health insurance.
  4. d. A college professor receives tenure (assurance of permanent employment) from her employer.
  5. e. A patient pays his surgeon before she performs the surgery.

To determine

Identify the statements that come under moral hazard and adverse selection.

Explanation

Moral hazard refers to the changes in the behavior of people after they have entered into a transaction that makes the other party in the transaction worse. Adverse selection refers to the situation in which one party in a transaction takes advantage of knowing more than the other party in the same transaction. It occurs when the sellers have better information than the buyers or vice-versa, and it can distort the usual market process.

Option (a):

Option (a) is an example of moral hazards because it shows the worse behavior of people after the transaction or exchange takes place.  In this case, the person becomes more carless after he has insured his car. Here, he converts his entire burden to the insurance company because he knows that his car is insured for a particular amount, and if there is any theft or accident that occurs on behalf of his carelessness, it will not affect him economically.

Option (b):

Option (b) is a clear example of adverse selection because in this case, the person believes that he will suffer from cancer in the future because it is inherited. Then, he decides to purchase the most complete health coverage available without any symptoms of cancer only because of his fear from his family history. Here, the exchange takes place before the confirmation of his disease due to the lack of information...

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