Final answer:
Moral hazard occurs when a person or entity takes on riskier behavior because they do not bear the full cost of the negative consequences, often due to having insurance. Businesses may install minimal security if insured, and banks might make riskier choices due to deposit insurance. Imperfect information exacerbates moral hazard as insurers cannot perfectly adjust premiums to match risk behaviors. The correct answer is option A leader demonstrates poor ethical behavior, leading to poor choices by employees.
Step-by-step explanation:
The concept of moral hazard is best defined as a situation where a person engages in riskier behavior, knowing that any negative consequences or losses will be absorbed by another party, typically due to the presence of insurance or similar protection. This behavior stems from the individual or entity feeling insulated from the risks associated with their actions. One common example of moral hazard is when individuals with health insurance might take fewer health precautions because they know medical costs are covered, potentially leading to higher incidence of claims.
Moral hazard can also occur in the business sector. Businesses may choose to implement only minimal security measures if they know they are protected by insurance, whereas they might install more comprehensive systems if they had to bear the full brunt of potential losses. Deposit insurance, while designed to protect bank depositors, can lead to risky behavior by banks themselves. Banks might engage in riskier investments or lending practices since the depositors' money is protected, potentially leading to financial instability.
Imperfect information contributes to the moral hazard problem, as insurance companies are unable to continuously monitor the risk levels of their insured parties. This imperfect knowledge means the company cannot always adjust premiums to accurately reflect the risk, leading to the moral hazard situation where insured parties might not act as vigilantly as they would if they stood to bear the full consequences of their actions.