Question

In the presence of moral hazard we can expect?

1) Prices to be too high
2) Prices to be too low
3) Quantities to be too low
4) All of the above could happen, depending on the circumstances

Answer 1

In the presence of moral hazard, prices can be too high, too low, or quantities can be too low, depending on the circumstances.

Step-by-step explanation:

In the presence of moral hazard, we can expect all of the above to happen, depending on the circumstances.

Moral hazard refers to the case when people engage in riskier behavior with insurance than they would if they did not have insurance. In this context, the presence of moral hazard can lead to various outcomes, including:

1. Prices to be too high: In some cases, insurance companies may increase premiums to account for the increased risk associated with moral hazard. For example, if people engage in riskier behavior knowing they are covered by insurance, the insurance company may charge higher premiums to offset the potential costs.
2. Prices to be too low: On the other hand, insurance companies may also offer lower premiums to attract customers and encourage them to purchase insurance. This can happen if insurance companies underestimate the risks associated with moral hazard and set lower prices than they should.
3. Quantities to be too low: Moral hazard can also lead to a decrease in the quantity of insurance coverage or services demanded. If people believe they are fully protected by insurance, they may take fewer precautions or engage in riskier behavior, resulting in a reduced need for insurance coverage or services.

Overall, the impact of moral hazard on prices and quantities is dependent on the specific circumstances and individuals involved. It is essential for insurance companies to carefully analyze the risks associated with moral hazard and set appropriate prices and quantities to ensure the stability and effectiveness of the insurance market.