Which of the following is an example of moral hazard?

• A. A person with car insurance drives more recklessly because they know damages will be covered.
• B. A company hides defects in its products before selling them.
• C. A seller knows more about the quality of a used car than the buyer.
• D. A bank lends money to a borrower without checking their credit history.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of moral hazard. Moral hazard occurs when one party takes more risks because they do not bear the full consequences of those risks, often due to some form of insurance or protection.
2. Step 2: Analyze each option to see if it involves a change in behavior due to protection or insurance against risk.
3. Step 3: For the first option, a person with car insurance drives more recklessly because they know damages will be covered. This fits the definition of moral hazard because the insurance reduces the driver's incentive to avoid risky behavior.
4. Step 4: The other options involve asymmetric information or lack of due diligence, which are related to adverse selection or information problems, not moral hazard.
5. Step 5: Conclude that the example illustrating moral hazard is the person driving more recklessly due to having car insurance.