problem. This is where the owner of a business (the principal) can't fully observe the productiveefforts of his employee or manager (the agent). Thus, a flat-rate of compensation foremployment, combined with the asymmetric information, can give the employee an incentive toshirk, or to not work as hard as he is capable of. He can follow his own best interest instead of fully pursuing the best interests of the owner by working diligently, as he will be paid the sameregardless of his performance.This is a problem within all areas of insurance and all of the different types of insurance that isoffered. People will buy the insurance and then feel falsely protected by it and act in a way thatis dangerous in general. For instance, if a person purchases fire insurance for his home, he mightnot be as careful to properly store flammable material or never use candles in the house, as hewas prior to obtaining insurance. Because of this, it may not be the best policy for governmentsto provide complete insurance for anything.This brings us to the relationship between moral hazard and unemployment insurance. Whenworkers are laid off or cannot find a job they may apply for unemployment insurance. In theUnited States, they are entitled to this for a limited time, while many countries in Europe allowthis collection of unemployment benefits to go on for an indefinite period of time. Because theseindividuals are receiving the benefits without doing the work they are less inclined to actuallyactively look for a job like they are supposed to. This creates a moral hazard because in thegovernment trying to help people without jobs they are actually giving them an incentive not tolook for another one. This is more of a problem in European countries and a reason why theyhave higher unemployment rates overall than the United States.
Market Failure -
At first, it may seem that the study of economics suggests that all goods andservices are efficiently provided for by the invisible hand. In other words, the correct number of goods and services will be provided and all shortages and/or surpluses will be resolved by wealthmaximizing individuals. Further, this will happen without government intervention. However, asimple look at the world around us will show that the government is quite involved in oureveryday market transactions. For example, in most states, the final purchase price of most goodsand services include a sales tax. Some goods like tobacco and alcohol have a further tax that maybe designed to alter people's behavior or "induce" them to do something more "socially"desirable. The existence of government intervention seems to suggest the invisible hand does notalways work; that the invisible hand does not always create the efficient outcome. Economistsrefer to this situation as market failure.In studying the sources of market failure (and how we may correct for the inefficiencies theycreate) economists typically look at three different categories. The categories are externalities,public goods, and imperfect information. When reviewing these pages, you will find that each of these topics are closely intertwined.
An externality is a result of market failure. The impact of an externality createscosts or benefits not reflected in the competitive market price. For example, the price that Lauraagrees to pay for George's house (my neighbor who likes to play loud, out of tune, guitar soloslate at night) does not include the benefit that I receive from no longer having George as myneighbor. Externalities are commonly referred to as "spillover" or "third-party" effects thatimpact parties beyond those considered in the decision making process of individuals or by the