A moral hazard occurs when one party is insulated from risk, leading them to take on greater risk than they would if they were fully exposed to the potential losses. In choice B, the party knows that the costs of their risky behavior will be borne by the other party in the transaction, hence they will take on more risk.

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A Moral Hazard

Question 100

Multiple Choice

A moral hazard

A) refers to the private, self-interested actions that people pursue, which, when taken collectively, lead to a loss in economic surplus.
B) refers to the situation where people tend to take risks after they have entered into a transaction because they know the costs will be borne by the other party in the transaction.
C) refers to the situation in which one party to a transaction takes advantage of knowing more than the other party to the transaction.
D) refers to the actions people take before they enter into a transaction so as to mislead the other party to the transaction.

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