Moral Hazard Definition & Examples?

1. What is Moral Hazard?

A moral hazard is a situation in which people’s incentives to take care of an asset (or themselves) change as a consequence of the way the asset is insured. Moral hazard results from an imbalance between those who bear the costs and those who enjoy the benefits of some activity.

2. Types of Moral Hazard?

Moral hazards can be divided into three different categories.

1. Adverse Selection:

When a customer has more information about the quality of a product than the seller, this creates asymmetric knowledge and may lead to problems with moral hazard

2. Incentive Compatibility:

This occurs when people have an incentive to behave in a certain way but when they insure themselves against the consequences of that behavior; they have no further incentive to behave in that way.

3. Risk Compensation:

This is when people take more risks because they are insured.

3. Moral Hazard in Insurance Markets?

This type of moral hazard occurs in insurance markets, where agents have private information about their individual risks. For example, patients may make false claims or not follow doctors’ instructions to avoid paying higher premiums.

4. Moral Hazard in Labor Markets?

A moral hazard occurs in labor markets when the employer provides insurance against wage variation (i.e., unemployment insurance). Workers can shirk knowing that they will receive benefits even if they do not work.

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5. Examples of Moral Hazard?

There are many examples of moral hazards:

  • Taking photos of objects that are clearly marked as “do not take photos” might be an example of a moral hazard.
  • Insurance fraud is one example of a moral hazard.
  • A drug addict who knows he can get free rehabilitation treatment could be said to have a moral hazard problem.
  • When your parents tell you not to play with matches because you could start a fire in the house, but then they leave matches out on the counter unattended.
  • Bribing public officials so that they can shirk their duties and instead work for money. This is also considered another form of moral hazard.
  • If you’re an owner of an unlicensed business, when your employees are working for you, they might turn a blind eye to customers using your business services without permission
  • When driving on the highway and the person in front of you slams his brakes for no reason.
  • When people act unethically when working under an agreement with confidentiality.
  • When someone is unemployed but doesn’t look hard enough for jobs because they know they can get unemployment benefits.
  • When someone speeds and gets away with it because there was no police car to give them a ticket even though the speed limit is 30mph, instead of slowing down their speed actually increases to 40 mph.