A homeowner discovers that a large tree in his yard is diseased and may fall in a bad windstorm and if it falls, it will likely destroy the garage. The cost to have the tree cut down is significant but the homeowner has an insurance policy and figures that if the tree falls and destroys the garage, the insurance company will pay, and the deductible is less than the cost to have the tree removed. This is an example of:
A) information symmetry.
B) adverse selection.
C) moral hazard.
D) screening.

Question

Quizplus · Accepted Answer

The homeowner's decision to take on the risk of keeping the diseased tree instead of proactively removing it is an example of moral hazard. The insurance policy provides a safety net that disincentivizes the homeowner from taking action to prevent the potential damage.

A Homeowner Discovers That a Large Tree in His Yard