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Externalities and the Environment

Meyer describes the “Tragedy of the Commons.” The IMF article explains how this type of problem is an example of an “externality.” What is an externality? What might be a good government policy to solve the problem of the environmental externality that leads to high greenhouse gas emissions?
Moral Hazard and Adverse Selection

“Moral hazard” is a term often used in the context of peoples’ behavior once they have insurance. Szuchman and Anderson explore the idea of moral hazard in personal relationships. How would you define moral hazard? Provide an example of a moral hazard that you have observed in your own community or workplace.

How does moral hazard differ from adverse selection? Provide an example to illustrate this concept.

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Externality

An externality is a cost or benefit that is imposed on a third party as a result of an economic activity. Externalities can be positive or negative. A positive externality is a benefit that is imposed on a third party, such as when a bee pollinates a farmer’s crops. A negative externality is a cost that is imposed on a third party, such as when a factory pollutes the air.

The Tragedy of the Commons is a classic example of a negative externality. In the Tragedy of the Commons, each individual shepherd has an incentive to graze as many sheep as possible on the common land. However, this leads to overgrazing and the destruction of the common land. This is a negative externality because the shepherds are imposing a cost on the other shepherds and on the community as a whole.

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Government Policy to Solve the Problem of Greenhouse Gas Emissions

One way for the government to solve the problem of greenhouse gas emissions is to impose a carbon tax. A carbon tax is a tax on the carbon content of fossil fuels. This would make fossil fuels more expensive and encourage people to use less of them.

Another way for the government to solve the problem of greenhouse gas emissions is to subsidize renewable energy sources, such as solar and wind power. This would make renewable energy more affordable and encourage people to switch to cleaner energy sources.

Moral Hazard

Moral hazard is a situation in which an individual’s behavior changes after they have insurance. For example, a person with car insurance may be more likely to drive recklessly because they know that their insurance will cover any damages.

One example of moral hazard that I have observed in my own community is the increase in healthcare costs. When people have health insurance, they are more likely to seek medical care, even for minor illnesses. This can lead to increased demand for healthcare services and higher healthcare costs.

Adverse Selection

Adverse selection is a situation in which one party to a contract has more information than the other party. For example, an insurance company may not know that a person is a high-risk driver until after they have already issued them a policy.

One example of adverse selection that I have observed in my own community is the increase in insurance premiums for young people. Insurance companies know that young people are more likely to file car insurance claims, so they charge them higher premiums.

Difference Between Moral Hazard and Adverse Selection

The main difference between moral hazard and adverse selection is that moral hazard occurs after a contract has been made, while adverse selection occurs before a contract has been made.

Another difference is that moral hazard is caused by a change in the behavior of one party to the contract, while adverse selection is caused by a lack of information between the two parties to the contract.

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