LH

Problem set 5

Definition of Moral Hazard

  • Moral Hazard: A situation where individuals take on greater risks because they do not bear the full consequences, relying on others (e.g., insurance) to cover costs if something goes wrong.

Non-Health Example of Moral Hazard

  • Car Insurance: An individual with car insurance may drive more recklessly, knowing that the insurance will cover damages in case of an accident.

Health Insurance Example of Moral Hazard

  • Health Insurance: A person might visit a doctor for non-essential issues, encouraged by the knowledge that insurance will cover the costs, thus leading to unnecessary healthcare usage.

Impact on Insurance Companies and Consumers

  • Impact on Insurance Companies:

    • Increased costs due to more claims from insured individuals taking more risks.
    • Potential financial losses because of avoidable claims.

  • Impact on Consumers:

    • Rising insurance premiums as companies adjust pricing to offset losses.
    • Reduced benefits or coverage availability for all customers, including those who act responsibly.

Missing Feature of a Perfect Market

  • In a perfect market, individuals bear the full cost of their decisions, leading to careful consideration. Moral hazard disrupts this principle as people do not face the true costs of their actions due to insurance coverage.

Solutions to Moral Hazard

  • Copayments or Deductibles: Require individuals to pay a portion of the costs when using insurance services, which encourages responsible usage and discourages overutilization of healthcare services.

Behavioral Economic Problems

  • Present Bias: Refers to the tendency of individuals to prioritize immediate gratification over long-term benefits.
    • Example: A person may indulge in junk food despite knowing it is unhealthy for their future health, prioritizing immediate pleasure over future health consequences.

Solutions to Behavioral Economic Problems

  • Using Reminders or Rewards: Implement tools or incentives that help individuals stay focused on long-term goals.
    • Example: A fitness app that rewards users with points or badges for regular workouts, incentivizing consistent healthy behavior despite the temptation to skip workouts.