Moral hazard and adverse selection are similar asymmetric information problems but moral hazard involves hidden actions while adverse selection involves hidden characteristics.

Question

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Moral hazard occurs when one party takes risks because they know the other party bears the consequences, often due to hidden actions that the other party cannot observe. Adverse selection, on the other hand, happens before a transaction occurs, when one party has more or better information about a relevant characteristic, leading to a potentially unfavorable selection based on hidden characteristics.

Moral Hazard and Adverse Selection Are Similar Asymmetric Information Problems