Which of the following is considered to be an example of moral hazard?

• A. A driver becomes less careful after purchasing comprehensive car insurance.
• B. A seller hides defects in a used car from potential buyers.
• C. A person with a chronic illness is more likely to buy health insurance.
• D. A lender cannot distinguish between high-risk and low-risk borrowers.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of moral hazard. Moral hazard occurs when one party takes on more risk because they do not bear the full consequences of that risk, often due to having insurance or some form of protection.
2. Step 2: Analyze each option to see if it fits the definition of moral hazard. For example, check if the behavior changes after obtaining insurance or protection, leading to riskier actions.
3. Step 3: For the option 'A driver becomes less careful after purchasing comprehensive car insurance,' recognize that the driver may take more risks because the insurance covers potential losses, which is a classic example of moral hazard.
4. Step 4: Contrast this with other options: hiding defects is an issue of asymmetric information (adverse selection or fraud), buying insurance because of illness is adverse selection, and lenders not distinguishing risk types is also adverse selection.
5. Step 5: Conclude that the example involving the driver becoming less careful after buying insurance best illustrates moral hazard, as it directly involves a change in behavior due to insurance coverage.