moral+hazard

=Moral Hazard=

Moral hazard is a situation in which one party to a contract takes a hidden action for their own benefit which occurs at the expense of the other party in the contract. An example of this would be someone with health insurance. This person knows that their health expense will be covered so they will do less to take care of themselves such as eating junk food and not exercising. These actions(eating junk food and not exercising) are the hidden action as the insurance company does not know the person is doing it. The benefit to the person is that they get to eat junk food and not exercise which increases the person's enjoyment of life. The cost is the reduced health which results in medical treatment which the person does not pay for but the insurance company does.

=Questions=

1. What is the hidden action in the following situation: Philip just started a new job with dental insurance. Philip stops brushing his teeth because he does not enjoy it. (A) Philip started a new job. (B) Philip now has dental insurance. (C) Philip has stopped brushing his teeth. (D) Philip does not like brushing his teeth.

=Answers=

//#1 Answer: C. Philip has stopped brushing his teeth. This is a hidden action because the insurance company does not know that Philip has done this and it benefits Philip while costing the insurance company.//