page_title: Moral hazard
section_title: Numerical example
hierarchical_section_title: Moral hazard / Numerical example
caption_attribution_description: English: A graphical representation of moral hazard in health insurance. The blue line represents marginal benefit of health care, the orange line represents marginal cost to the individual without health insurance, and the grey line represents marginal cost to the individual with health insurance.
context_page_description: In economics, moral hazard occurs when an entity has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a corporation is insured, it may take on higher risk knowing that its insurance will pay the associated costs. A moral hazard may occur where the actions of the risk-taking party change to the detriment of the cost-bearing party after a financial transaction has taken place.
  Moral hazard can occur under a type of information asymmetry where the risk-taking party to a transaction knows more about its intentions than the party paying the consequences of the risk and has a tendency or incentive to take on too much risk from the perspective of the party with less information. One example is a principal-agent problem, where one party, called an agent, acts on behalf of another party, called the principal. If the agent has more information about his or her actions or intentions than the principal then the agent may have an incentive to act too riskily if the interests of the agent and the principal are not aligned.
context_section_description: Consider a potential case of moral hazard in the health care market caused by the purchase of health insurance. Assume health care has constant marginal cost of $10 per unit and the individual's demand is given by . Assuming a perfectly competitive market, at equilibrium, the price will be $10 per unit and the individual will consume 10 units of health care. Now, consider the same individual with health insurance. Assume this health insurance makes health care free for the individual. In this case, the individual will have a price of $0 for the health care and thus will consume 20 units. The price will still be $10, but the insurance company would be the one bearing the costs.
  This example is shown graphically at the right. The blue line represents the downward sloping marginal benefit curve. The orange line represents the constant marginal cost curve without insurance. The green star is the market equilibrium. When the individual is insured, the marginal cost curve shifts down to 0, leading to a new equilibrium at the yellow star.
  This example shows numerically how moral hazard could occur with health insurance. The individual consumes more health care than the equilibrium quantity because they don't bear the cost of the additional care.  
caption: A graphical representation of moral hazard in health insurance.
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