Question

All MegaCorp employees who stay on the job for more than three years are rewarded with a 10 percent pay increase and coverage under a private health insurance plan that MegaCorp pays for. Tina just passed three years as a MegaCorp employee and reacts to having health insurance by taking up several dangerous sports because now she knows that the insurance plan will pay for any injuries that she may sustain. This change in Tina's behavior is known as: a. Defensive medicine. b. Asymmetric information. c. The moral hazard problem. d. The personal mandate.

Short answer

c. The moral hazard problem.

Step-by-step solution

Understanding the Terms

First, we need to understand the terms mentioned: 'Defensive medicine' is when medical professionals order tests to protect themselves from lawsuits. 'Asymmetric information' occurs when one party has more or better information than the other. 'The moral hazard problem' is when a person is more likely to take risks because they do not bear the full consequences; often due to insurance. 'The personal mandate' typically refers to laws requiring individuals to have health insurance.

Analyze Tina's Behavior

Tina's behavior change upon getting health insurance involves taking more risks because she knows the insurance will cover her injuries. This implies she's now acting differently than she did without insurance coverage, taking on additional risk because the financial consequences are mitigated.

Match Tina's Behavior to the Concepts

Considering the definitions, Tina's behavior most closely matches 'The moral hazard problem', where she is taking more risks because she is shielded from the costs of potential injuries by the insurance provided by MegaCorp.

Key concepts

Asymmetric Information

In economics, **asymmetric information** refers to a situation in which one party in a transaction possesses more or better information than the other party. This often leads to inefficient outcomes in the marketplace. Imagine trying to buy a used car. As a buyer, you might not know if the car has hidden mechanical issues, whereas the seller, who has driven the car regularly, has more complete knowledge.
The concept becomes particularly relevant in scenarios like health insurance. Here, the insurance provider may not know which individuals are likely to take more risks once insured, which can lead to problems in setting the right premium rates.

• This type of information imbalance can lead to market failures, as decisions made with partial information might not yield the most efficient resource allocation.
• Economic theories often explore how mechanisms can be put in place to reduce information asymmetry.

To manage these issues, companies may implement measures such as requiring full disclosure, or they may engage in practices like screening and signaling to gather more accurate information.

Insurance Incentives

**Insurance incentives** are designed to impact the behavior of those who are insured. Ideally, these incentives align the insured’s interests with those of the insurer, minimizing unnecessary risks and keeping costs low. Unfortunately, these incentives sometimes lead to what's known as moral hazard.

• For instance, if individuals like our example, Tina, believe their insurance covers all eventualities, they might engage in riskier activities, knowing they won't bear the full financial consequences of their actions.
• Insurers try to mitigate this through **deductibles**, where the insured must pay a portion of any claim, or **copayments**, which are fixed costs paid by the insured for services, to encourage more prudent behavior.

Insurance companies often walk a fine line, ensuring incentives are appropriate to deter risky behavior, while still providing adequate coverage.

Behavioral Economics

**Behavioral economics** delves into how psychological factors influence economic decision-making. Unlike traditional economics, which assumes complete rationality, behavioral economics recognizes that people's choices are often less than perfectly rational. Tina's shift in behavior upon receiving health insurance offers a classic example of this.

• Her decision to partake in risky sports due to newfound coverage reveals a psychological shift. Despite the increased risk of injury, the financial safety net provided by insurance affects her decisions, demonstrating how real-life decisions often deviate from the rational-choice model.
• Understanding these psychological tendencies allows economists to predict and analyze consumer behavior. Businesses and policymakers utilize these insights to craft policies and products that nudge individuals towards choices beneficial both for the individual and society.

Behavioral economics emphasizes the importance of understanding non-rational influences like fear, optimism, and perceived value in shaping our economic world.