Suppose a firm offers its workers a cafeteria plan in which it allows workers to allocate a set amount of fringe benefit money toward specific insurance. Mary, who has five kids needing braces, selects the family dental coverage. This is an example of the
A)free-rider problem.
B)principal-agent problem.
C)adverse selection problem.
D)moral hazard problem.

Question

Quizplus · Accepted Answer

The choice of family dental coverage by Mary, who has a higher than average need for dental services due to her five kids needing braces, is an example of the adverse selection problem. Adverse selection occurs when one party in a transaction has more information than the other, typically leading to a situation where the party with more information selects goods or services that benefit them at the expense of the other party. In this case, the insurance provider faces the risk of loss due to not being able to accurately price the insurance because of not knowing individual needs beforehand.

Suppose a Firm Offers Its Workers a Cafeteria Plan in Which