Identify an example of a management scenario from current events involving adverse selection or moral hazard. Discuss some methods with your classmates for correcting the potential problems of the asymmetric information.
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Moral hazard is a situation in which one party engages in risky behavior or fails to act in good faith because it knows the other party bears the economic consequences of their behavior. Any time two parties come into an agreement with one another, moral hazard can occur. A driver in possession of a car insurance policy may exercise less care while operating their vehicle than an individual with no car insurance. The driver with a car insurance policy knows that the insurance company will pay the majority of the resulting economic costs if they have an accident. Any time an individual does not have to suffer the full economic consequences of a risk, moral hazard can occur. In the business world, moral hazard can occur when governments make the decision to bailout large corporations. Moral hazard is also more likely to occur when there are certain methods of salesperson compensation
There are a few broad methods of addressing the adverse selection problem. One very clear solution is for producers to provide warranties, guarantees, and refunds. This is particularly notable in the used car market. In addition to seller-granted warranties, third-party companies can offer their own warranties in the form of insurance that comes at some cost to the consumer. In addition, the government can step in to regulate the quality of good sold. In most states, there are “lemon laws” where a consumer can return a faulty used car back to the dealer no questions asked within a certain initial time period if it turns out to be a piece of junk. Another intuitive and natural response is for consumers and competitors to act as monitors for each other. Consumer Reports, Underwriters Laboratory, notaries public, and online review services such as Yelp help bridge gaps in information. eBay and Amazon seller ratings, Uber driver reviews, and product ratings are all examples of crowd-sourcing reputation in this way. Finally, the study of efficient market arrangements is known as mechanism design theory, which is a more flexible offshoot of game theory.