What is the term for a situation in which distorted incentives arise because an individual has private information about their own actions, but someone else bears the costs of a lack of care or effort?

Question

BlackTom AI · Accepted Answer

Moral hazard occurs when one party can take unobserved actions that affect the payoff of another party, creating distorted incentives because the actor does not bear the full cost of their behavior.

Relevant concepts: asymmetric information, hidden action (moral hazard) versus hidden type (adverse selection), principal–agent problems, and incentive alignment. In moral hazard the key features are (1) after a contract or relationship is established, one party’s effort or care is not fully observable, and (2) losses or costs are borne (in whole or in part) by someone else.

Step-by-step reasoning:
1. Identify the elements described: (a) the individual has private information about their own actions (hidden action), and (b) someone else bears the costs of a lack of care or effort. These map exactly to the definition of moral hazard.
2. Apply the principal–agent framework: the agent chooses effort e. The principal’s payoff depends on e, but cannot monitor e perfectly. Because the agent does not internalize the full adverse consequences, they choose lower effort than the socially optimal level.
3. Provide examples: an insured driver may drive less carefully because the insurer covers accident costs; a bank may take excessive risks if it expects government bailouts; an employee may shirk when supervision is weak.

Why moral hazard is correct: it specifically captures "hidden actions" and incentive distortion after contracting where costs fall on others. That matches the wording in the question exactly.

Why other options are incorrect:
- Adverse selection: involves hidden information about a party’s type before a transaction (e.g., high-risk drivers buying insurance), not hidden actions after the contract.
- Upper hand: colloquial phrase, not a technical economic term describing this phenomenon.
- Game theory: the broader field studying strategic interaction, not the specific situation described.
- Prisoner’s dilemma: a particular strategic game demonstrating non-cooperative equilibrium and mutual defection; it does not hinge on hidden actions after contracting.

Conclusion: The correct term is moral hazard, which matches the provided answer.

What is the term for a situation in which distorted incentives arise because an individual has private information about their own actions, but someone else bears the costs of a lack of care or effort?单项选择题

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