Define Adverse Selection and Moral Hazard and Give Examples of Each

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The Answer is Moral hazard exists when an insured party whose actions are unobserved can affect the probability or magnitude of a payment associated with an event.For example,if Jack buys fire insurance and the insurance company cannot (at reasonable cost)observe where he keeps his old newspapers,he has less incentive to keep his old newspapers away from the fireplace because he will be compensated if a fire does occur.
Adverse selection is a form of market failure resulting from asymmetric information.It arises when products of different qualities are sold at a single price because one party (buyer or seller)is not sufficiently informed to determine the true quality of the product at the time of purchase.For example,if an insurance company cannot distinguish among low-risk and high-risk individuals and must charge a single premium to all,more high-risk individuals will want to buy insurance,potentially making it unprofitable to sell insurance.

Define Adverse Selection and Moral Hazard and Give Examples of Each

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