Examples where information is

available to buyers but not to sellers

• Insurance services
• Buyer knows his personal health condition
than compared to seller of the insurance
• Moral hazards- when a party whose actions
are unobserved can affect the probability or
magnitude of a payment associated with an
event. In other words where one party take
the risks but does not face the full costs of
these risks.
• Definition: Moral hazard is a situation in which one party gets involved in a
risky event knowing that it is protected against the risk and the other
party will incur the cost. It arises when both the parties have incomplete
information about each other.
Description: In a financial market, there is a risk that the borrower might
engage in activities that are undesirable from the lender's point of view
because they make him less likely to pay back a loan.
It occurs when the borrower knows that someone else will pay for the
mistake he makes. This in turn gives him the incentive to act in a riskier
way. This economic concept is known as moral hazard.
Example: You have not insured your house from any future damages. It
implies that a loss will be completely borne by you at the time of a
mishappening like fire or burglary. Hence you will show extra care and
attentiveness. You will install high tech burglar alarms and hire watchmen
to avoid any unforeseen event.
But if your house is insured for its full value, then if anything happens you
do not really lose anything. Therefore, you have less incentive to protect
against any mishappening. In this case, the insurance firm bears the losses
and the problem of moral hazard arises.
 Adverse Selection and Moral Hazard

Insurance Companies generally have kinds of problems:

(1) People come in different types:
High risk/Low risk, healthy/unhealthy.
The customers know something the company doesn’t.
= ADVERSE SELECTION
(2) People take actions the company does not see:
Drive carefully/not, Exercise/no.
The customers do something the company doesn’t.
= MORAL HAZARD
• In a free unregulated markets, the result of
MH is to underallocate resources to the
production of insurance services as sellers of
the insurance try to protect themselves
against higher costs due to risky behaviour of
the buyers of the insurance
 Evaluating responses to MH
• Out of pocket payments- when the buyer of
insurance pay for part of the cost of damages
• Premium is an amount paid periodically to the
insurer(bank) by the insured (buyer)for
covering his risk.
• In an insurance contract, the risk is transferred
from the insured to the insurer. For taking this
risk, the insurer charges an amount called the
premium.
 private insurance company offer a range of
policies from which buyer s can choose
Low income earner- low cost
policy (low premium), high out of
pocket payments- these are more
affordable regardless of the state
of their health- they know their
health condition assume that they
are prone to low risk of getting
sick-change their risky behaviour-
less insurance protection
High income earner- high cost
policy, low OPP- less risky
behaviour- more insurance
protection
• Insurance company try to protect themselves
against high risks
• Refuse to insure people above a certain age-
elderly people generally have high chance of
being ill
• Gov responses: direct provision of health care
services at low / zero prices to an entire
population
• Spend tax revenue on NHS
• Problem- expenditure incurred by the
government- burden on the budget
 The problem of safety in the
workplace and possible responses
• Safety in the workplace-
• Employers hide info about the workplace health and
safety
• Represent the market failure due to AS in the labour
market
• Evaluation:
• Government can provide info to workers about safety
conditions in various firms
• Set minimum safety standards in the work place
Trade union- collectively bargain for wages, working
condition and hrs of work
Private sector Gov sector
• Apollo Munich Health • LIC
Insurance. • United india insurance
• Bajaj Allianz General • National insurance
Insurance. corporation of india
• HDFC ERGO General • Oriental insurance
Insurance Company. corporation of india
• ICICI Lombard.