Question

Moral hazard occurs when

a. an employer closely monitors an employee.
b. two people consider a trade with each other and one person has relevant information about some aspect of the product's quality that the other person lacks.
c. an employee lacks an incentive to promote the best interests of the employer, and the employer cannot observe the actions of the employee.
d. an employee closely monitors the actions of her employer.

Answer 1

The correct answer to the question is option c, as it reflects the scenario where an employee may not have the incentive to work in the employer's best interest, especially when their actions go unobserved.

Step-by-step explanation:

Moral hazard occurs when there is a tendency for an individual or business to take more risks because they are protected from the consequences, often through an insurance policy. Option c. an employee lacks an incentive to promote the best interests of the employer, and the employer cannot observe the actions of the employee, is the correct answer to the student's question about moral hazard. This is because the employee might not act in the employer's best interest if their actions are unobserved and their risks or mistakes are insured against. Imperfect information exacerbates moral hazard as it becomes difficult for an insurance company to adjust premiums based on the real-time risk behavior of the insured party.