What Is The Difference Between Moral Hazard And Adverse Selection?

What Is The Difference Between Moral Hazard And Adverse Selection?
Share

1 Answer

  1. Both adverse selection and moral hazard is the result of asymmetric information. Moral hazard occurs when there is asymmetric information between a buyer and a seller and a change in behavior after a deal while adverse selection occurs when there is asymmetric information between a buyer and a seller prior to a deal. To explain adverse selection, it could be illustrated by market of lemons. n this market, the sellers have more knowledge about the quality and the history of their cars than the buyers. For example, we’ll assume there are two types of cars in this market, high-quality cars (peaches) and low-quality cars (lemons). The sellers know whether a car is a lemon or not, but the buyers cannot distinguish between the two (since lemons can only be identified as such after they have been bought). Hence the buyer would quote a real low price and therefore the peaches will leave the market and sellers of lemons would still stay this way it could prevent the adverse selection.
    The example of moral hazard could be explained by the carelessness adopted by the insuree after getting the insurance. For example if an insurer buys a car and does not care for it because anyway it has insurance then this is called problem of moral hazard.
    Hence, adverse selection and moral hazard describe many different situations between two parties where one of them is at a disadvantage due to a lack of information.

    • 0