Asymmetric information

- Where one party doing an exchange has more or better information than the other party
- When one party has an information advantage, they use it to exploit other party that can lead to
moral hazard

Moral Hazard

- moral hazard occurs when one party or individual in a transaction takes risks knowing that, if
things don't work out, another party or individual then suffers the burden of the adverse
consequences.

Solutions

1. Make information less asymmetric

- Similar or balanced information can’t easily exploit the other party

Ex. By reading reviews about the seller beforehand, the buyer will be able to know if the service
is reliable or the product has a good quality, this will help in balancing the information between
the buyer and seller.

2. Reduce the incentives

- To maintain reputation the informed party will not behave inappropriately

Ex. Relative to first example, the seller will not exploit the buyer if they know that it will result in
a negative online review that may affect the reputation of the seller and the business.

3. Modifying Incentives

Ex. When you go to a doctor for a check-up, that doctor is simply diagnosing the problem, but
not doing the actual treatment. This eliminates the incentive to run up the bill. By the time
you’re ready to fix the issue, this separate diagnosis by the doctor allows you to have much
more information, making the information with the service provider (doctor 2) less asymmetric.
This can help to mitigate issues of moral hazard.

References:

https://www.youtube.com/watch?v=5v7TWKlYoN0

https://www.youtube.com/watch?v=6faL76QZ2AA

https://www.investopedia.com/ask/answers/042715/what-are-most-effective-ways-reduce-moral-
hazard.asp