You offer an extended warranty for your product that is purchased by a few customers.If the product typically fails 2% of the time,the claim rate will exceed 2% of warranty purchasers because
A)adverse selection will lead those who are more reckless to purchase the warranty
B)moral hazard will lead those who purchase to be more reckless
C)you systematically underestimate product failure rates
D)a and b.

Question

Quizplus · Accepted Answer

Adverse selection will lead more reckless customers to purchase the warranty, increasing the likelihood of claims. Moral hazard will also lead customers who have purchased the warranty to be more reckless, knowing they are protected against failure. These factors combined lead to a claim rate that exceeds the expected product failure rate of 2%.

You Offer an Extended Warranty for Your Product That Is