Asymmetric Information and Moral Hazards

Asymmetric Information is a situation in which one member has more information than the other during a tranaction. This often happens when either the buyer or the seller have more information about a particular thing than the other. Theoretically, this is a negative situation because one party can take advantage of the other party's lack of knowledge.¹

Problems faced by Assymetry of Information

1. Moral Hazard- unethical conduct that benefits from information asymmetry AFTER a deal. For example, if Mr. X  has a life insurance, they are more likely to drink and drive and act carelessly.

2. Adverse selection- unethical conduct that benefits from information asymmetry BEOFRE a deal. For example, a person who is not keeping good health os more likely to take a life insuarnce than the person who is fit

”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.”

                                    -The Economic Times

 Examples:
1) a person with insurance against car burglary may be careless about securing their car because the negative penalties of automobile burglary are now the concern of the insurance firm. A party makes a choice about how much risk to take, while another party bears the costs if things go badly, and the party protected from danger behaves in a different way from how it would if it were fully visible to the danger.²

2)  When you are not insured, you take extra care by brushing and flossing tiwce a day because you are aware that a dental problem is going to cost you a fortune. However, you manage to get a dental insurance through a new job and your incentive of taking care of your teeth reduces because of the insurance. The insurance company still thinks you are taking good care of your teeth and gums and if you have any problem, you’ll go to the dentist to fix it. Therefore, you have information that the insurance company does not, and if the firm doesn’t get to know of this soon, they are risking the fact of not charging you a high premium. It is more likely that customers like you would put them out of business.³

Solutions:

1.   Regulations:
Governments can pass laws to ensure moral ethics and security characteristics that must be

maintained by both the parties.

Problems faced:

-Since the population is massive, legislations are time consuming and slow down financial activities.

·         -These activities are expensive and have great opportunity costs.

 

2. Provision of Information: 
Governments may openly stream data to customers, or force manufacturers to provide data, therefore shielding customers in their buying choices.

Problems faced:

• There may be loops in the data and hitches in the gathering and opportunity cost of the data.
• It is not constantly probable to eliminate asymmetric information completely, because of some secreted data.

CITATIONS:

¹ "Asymmetric Information Definition | Investopedia." Investopedia. N.p., 19 Nov. 2003. Web. 09 Jan. 2016.

² Wikipedia. Wikimedia Foundation, n.d. Web. 09 Jan. 2016.

³ "Moral Hazard in Economics: Definition & Examples." Study.com -Introduction to Buisness. N.p., n.d. Web. 09 Jan. 2016.