Moral Hazard: People are more likely to take risks when they know they won't bear the full consequences of their actions.
Article: Moral Hazard: Definition, Meaning, Examples, and How to Manage
Moral hazard is a situation where people take more risks because they know they will not bear the full consequences of their actions. In other words, one increases exposure to risk because one does not pay the total costs of that risk.
For example, when someone has car insurance, they may be more likely to drive recklessly because they know the insurance company will cover any damages. Similarly, suppose a company receives a bailout from the government. In that case, they may be more inclined to take on risky investments or engage in unethical behavior because they know they will not suffer the full consequences of their actions. In both cases, the party taking the risk has less incentive to act responsibly because they know someone else will bear the costs of their actions.
It's noteworthy that adverse selection arises from a lack of information, while moral hazard arises from a lack of incentives. Adverse selection can lead to unequal or unfair exchanges, while moral hazard can lead to excessive risk-taking or reckless behavior.