Each Situation Involves Either Moral Hazard or Adverse Selection

question 101

Essay

Each situation involves either moral hazard or adverse selection.In each case,identify whether it is a case of moral hazard or adverse selection and find the principal and agent for each situation.
a.A security deposit is required for the summer cottage rental.
b.A one-week-old 2014 Ford Flex is selling at a price that is 30 percent lower than the brand new one.
c.A high-tech company gives stock options to their senior employees.
d.A house insurance premium is lower for people who install a monitoring system in their house.

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Definitions:

Pre-Merger Market

The financial and economic conditions affecting companies and their stock prices before they undergo a merger.

External Growth

Expansion of a business through acquiring or merging with other companies, as opposed to internal growth through increasing sales, product lines, or efficiencies.

Diversification

In finance, selecting a portfolio of different (diverse) investments to limit the overall risk borne by the investor.

Economies of Scale

Cost advantages that a business can achieve due to expansion and increased production volume, leading to lower per-unit costs.