23-Moral Hazard

Question 1

Define Moral Hazard

Answer 1

situation where Individual or Organization take Greater Risk knowing that Costs that incurs will be Borne by Other Economic Agents
So there’s no incentive to take normal precautions and act sensibly, this results in UNNECESSARY risk taking and subsequent failure

Question 2

Give Examples of Moral Hazard

Answer 2

–> Banking
–> Insurance

Question 3

Elaborate the Example of Moral Hazard
–> Banking

Answer 3

To ensure Economic and Financial Stability, there’s an Implicit understanding that the Govt would prevent Banks from going Bankrupt. However, this creates a Moral Hazard since banks will take Risks as they know they would be BAILED OUT by Govt (with TAXPAYER’S Money) if they were in risk of going BANKRUPT. This is the one of the main reason of Financial Crisis in 2008

Question 4

Elaborate the Example of Moral Hazard
–> Insurance

Answer 4

Insurance Market may lead to a problem of Moral Hazard when people take more Risks because they are Insured
If people have car Insurance they may take more Risk because they are not responsible for Paying the Medial and Repair Costs if they have an Accident