When a night watchman only performs two walk-throughs per night when he is being paid to perform five walk-throughs per night, it is an example of
A)both moral hazard and adverse selection.
B)neither moral hazard nor adverse selection.
C)moral hazard, but not adverse selection.
D)adverse selection, but not moral hazard.

Question

Quizplus · Accepted Answer

Moral hazard occurs when one party in a transaction has the opportunity to assume additional risks that negatively affect the other party because the latter cannot adequately monitor the former's behavior. In this case, the night watchman's failure to perform the agreed number of walk-throughs, due to the employer's inability to monitor every action, is a classic example of moral hazard. It is not an example of adverse selection, which refers to a situation where one party has more or better information than the other before the transaction occurs, leading to a poor selection of risks.

When a Night Watchman Only Performs Two Walk-Throughs Per Night