Asymmetric Information and Moral Hazards
Asymmetric Information is a situation in which one party in a transaction has more or superior information as compared to another. This often happens in transactions where the seller knows more than the buyer, although the reverse can happen as well.
Moral Hazard is when an individual takes additional risk because he is insured. This occurs when the party receiving the insurance does not take full responsibility for its actions. The insured party has more information or knowledge concerning its intention, than the insuring party does.
An example for Moral Hazard is in the case of insurance for houses. When somebody's house is insured they do not have incentive to protect it from any mishaps. The cost of any mishap goes to the insurance company. In case it was not insured special care would be taken with extra money spent on security guards, cameras, etc. to match circumstances like burglaries. When the house is insured and there is less incentive to protect it the problem of Moral Hazard arises.
The US government has ordered Volkswagen to recall almost 500,000 cars after it was found that the car could produce 40 times more pollution than allowed. In this case the producers or sellers have more information as compared to the consumers who may now have to pay additional charges in the future which leads to the problem of Moral Hazard. The company may have to recall the cars and this leads to long term problems where they may have to replace the engines which could cost billions of dollars. Also the customers owning the cars will be adversely affected as they have to return the cars and this situation leads to a Moral Hazard where the sellers held important pertinent information and did not disclose it.
Solutions for moral hazards exist. Problems relating to insurance are generally dealt with by the provider of the insurance. This may be done by making the buyer of the insurance pay part of the cost of damages and these payments are known as "out of pocket payments". This gives incentive for less risky behavior from the buyer of insurance. By paying part of the money risky behavior is from the consumers is avoided.
Moral hazards are dealt with through government regulations in the financial sector. For these to be effective a wide range of government regulations are implemented.
Citations:
"Volkswagen under Investigation." The Guardian. N.p., n.d. Web.
"Moral Hazard Definition | Moral Hazard Meaning - The Economic Times." The Economic Times. N.p., n.d. Web. 10 Jan. 2016.
"Asymmetric Information Definition | Investopedia." Investopedia. N.p., 19 Nov. 2003. Web. 10 Jan. 2016.
"Volkswagen's Diesel Scandal, Explained." YouTube. YouTube, n.d. Web. 10 Jan. 2016.
Asymmetric Information is a situation in which one party in a transaction has more or superior information as compared to another. This often happens in transactions where the seller knows more than the buyer, although the reverse can happen as well.
Moral Hazard is when an individual takes additional risk because he is insured. This occurs when the party receiving the insurance does not take full responsibility for its actions. The insured party has more information or knowledge concerning its intention, than the insuring party does.
An example for Moral Hazard is in the case of insurance for houses. When somebody's house is insured they do not have incentive to protect it from any mishaps. The cost of any mishap goes to the insurance company. In case it was not insured special care would be taken with extra money spent on security guards, cameras, etc. to match circumstances like burglaries. When the house is insured and there is less incentive to protect it the problem of Moral Hazard arises.
A real life example of Moral Hazard was seen in the recent Volkswagen Emission Scandal.
The US government has ordered Volkswagen to recall almost 500,000 cars after it was found that the car could produce 40 times more pollution than allowed. In this case the producers or sellers have more information as compared to the consumers who may now have to pay additional charges in the future which leads to the problem of Moral Hazard. The company may have to recall the cars and this leads to long term problems where they may have to replace the engines which could cost billions of dollars. Also the customers owning the cars will be adversely affected as they have to return the cars and this situation leads to a Moral Hazard where the sellers held important pertinent information and did not disclose it.
Solutions for moral hazards exist. Problems relating to insurance are generally dealt with by the provider of the insurance. This may be done by making the buyer of the insurance pay part of the cost of damages and these payments are known as "out of pocket payments". This gives incentive for less risky behavior from the buyer of insurance. By paying part of the money risky behavior is from the consumers is avoided.
Moral hazards are dealt with through government regulations in the financial sector. For these to be effective a wide range of government regulations are implemented.
Citations:
"Volkswagen under Investigation." The Guardian. N.p., n.d. Web.
"Moral Hazard Definition | Moral Hazard Meaning - The Economic Times." The Economic Times. N.p., n.d. Web. 10 Jan. 2016.
"Asymmetric Information Definition | Investopedia." Investopedia. N.p., 19 Nov. 2003. Web. 10 Jan. 2016.
"Volkswagen's Diesel Scandal, Explained." YouTube. YouTube, n.d. Web. 10 Jan. 2016.
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