Question

When Joe didn't have renter's insurance, he was very careful not to leave candles lit in his apartment and locked the door when he left. Now that he has renter's insurance, he typically leaves candles burning all day and forgets to lock the door, because he knows that even if his apartment catches on fire or gets broken into, his insurance will cover it. Which of the following economic problems is characterized in the story? a) The free-rider problem b) Moral hazard c) Government failure d) Adverse selection

Answer 1

Answer:

Moral hazard

Explanation:

• Moral hazard is a term used in economics that refers to the fact that one person tends to increase his/her exposure to risks when they are insured. Specially when someone else will bear the cost of those risks.
• The free-rider problem refers to the situation where individuals are able to consume a good without paying for it.
• Government failure is a term used in economics to refer to when the government intervenes in the economy to try to fix a problem but its intervention actually make things worse.
• Adverse selection refers to when buyers and sellers have different information regarding one product and the risks this misinformation leads to.

In the example, we can see that Joe was very careful when he didn't have a renter's insurance. However, now that the situation has changed, he leaves candles burning all day and forgets to lock the door because he knows that even if something happens, someone else will pay for it.

Thus, this example has all the characteristics of a Moral Hazard.