raghu wrote:
On Nov 30, 2007 12:47 PM, David B. Shemano wrote:
As a good free-marketer, I am against Subsidized Moral Hazard, but am entirely
neutral regarding Moral Hazard.
Yet one of the main insights from the analysis of moral hazard is that a
free-market can not be relied upon. A market will always be incomplete when
moral
hazard exists. In the case of insurance, for example, firms cannot provide full
coverage because the level of care cannot be observed. Non-market arrangements,
or
institutional routines, are therefore developed in place of a pricing system.
In
other words, in the presence of moral hazard, markets do not provide appropriate
incentives for the acquisition and dissemination of information.
If I understand correctly in your first case that you call "Moral
Hazard" everyone understands the risks including the behavioral ones
and presumably the insurance will be appropriately priced taking it
into account. So in that sense there is no problem.
I think the point about the moral hazard problem is that the insurance will not
be
appropriately priced. The insurance premium is associated with the average risk,
and therefore, the average care, taken by the group of individuals. When each
individual ignores the effect of his or her actions on the premium, that premium
will tend to increase. The lack of care by each exerts a negative externality on
others. Private markets cannot deal with such situations; social institutions
are
needed instead.
