Wednesday

 Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART 7 Topics for Further Study
Chapter 22 of 36 Frontiers of Microeconomics
Section 4 of 18
…
The economics of asymmetric information, continued.
The general definition of moral hazard is the lack of incentive to guard against risk where one is protected from its consequences.
In microeconomics moral hazard specifically is a problem that arises when
· one person, the agent, is performing some task
· on behalf of another person, the principal
If the principal cannot perfectly monitor the agent's behavior the agent tends to make less effort than the principal considers desirable.
The agent is protected from consequences due to asymmetrical information.
…
A classic moral hazard example is the employer-employee relationship.
The employer is the principal, and the worker is the agent.
The moral hazard problem is the temptation of imperfectly monitored workers to shirk their responsibilities, to not make the full effort expected of them.
Employers respond to this problem in various ways.
Better monitoring, e.g. parents hiring nannies can have hidden video cameras to record the nanny's behavior.
High wages, employers can pay their workers a wage above the market equilibrium.
Workers who earn an above-equilibrium wage are less likely to shirk because if they are caught and fired they might not be able to find another such high-paying job.
Pay all or part of compensation as a commission, e.g. pay a salesperson a percent of the sales she generates.
Firms can delay part of a worker's pay.
So, if the worker is caught shirking and is fired, he sacrifices the delayed pay.
The year-end bonus is an example of delayed compensation.
…
There are many examples of moral hazard.
A homeowner with fire insurance will likely buy too few fire extinguishers.
A family may live near a river with a high risk of flooding because the family enjoys the scenic views while the government bears some or all of the cost with disaster relief after a flood.
Many regulations are aimed at addressing the moral hazard problem.
An insurance company may require homeowners to buy a certain number of fire extinguishers.
The government may prohibit building homes on land with high risk of flooding.
But the problem of moral hazard persists.
The insurance company does not have perfect information about how cautious homeowners are.
The government does not have perfect information about the risk families undertake when choosing where to live.
… …
moral hazard
moraru hazādo
モラルハザード

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