Question

When Joe didn't have car insurance, he drove very cautiously, because he knew he would have to pay for any damage to his car. Now that he has car insurance, he tends to speed more, because he knows that even if he gets into an accident, his insurance will cover it.

The economic problem in this story is known as:
a) Adverse selection
b) The winner's curse
c) Signaling
d) Moral hazard

Answer 1

Option (d) is correct.

Step-by-step explanation:

Moral hazard refers to a risk which arise from the information provided by the either party in a particular contract. Moral hazard are of many types:

(i) Providing misleading information

(ii) Once the contract is established then either of the party can take higher risk

Moral hazard can be present in a contract between the parties at any point of time. Each party in an agreement have an incentive or we can say that opportunity for gaining from the actions that are not laid out in an agreement.

In our case, the economic problem is moral hazard because after being insured he will be able take higher risk as the probability of loosing money is minimal.