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Moral Hazard

Moral Hazard is a broad topic that addresses several areas within Economics.  It is defined as an adverse behavior that is brought on by allowing people to buy insurance for an adverse event. This entails when a person's behavior is hard to monitor and control and thus payment to that person is based on incomplete information. This usually occurs in the insurance and job markets. In the workplace, moral hazard is generally known as the principal-agent problem. This is where the owner of a business (the principal) can't fully observe the productive efforts of his employee or manager (the agent). Thus, a flat-rate of compensation for employment, combined with the asymmetric information, can give the employee an incentive to shirk, or to not work as hard as he is capable of. He can follow his own best interest instead of fully pursuing the best interests of the owner by working diligently, as he will be paid the same regardless of his performance.

This is a problem within all areas of insurance and all of the different types of insurance that is offered.  People will buy the insurance and then feel falsely protected by it and act in a way that is dangerous in general.  For instance, if a person purchases fire insurance for his home, he might not be as careful to properly store flammable material or never use candles in the house, as he was prior to obtaining insurance.  Because of this, it may not be the best policy for governments to provide complete insurance for anything.

This brings us to the relationship between moral hazard and unemployment insurance.  When workers are laid off or cannot find a job they may apply for unemployment insurance.  In the United States, they are entitled to this for a limited time, while many countries in Europe allow this collection of unemployment benefits to go on for an indefinite period of time. Because these individuals are receiving the benefits without doing the work they are less inclined to actually actively look for a job like they are supposed to.  This creates a moral hazard because in the government trying to help people without jobs they are actually giving them an incentive not to look for another one.  This is more of a problem in European countries and a reason why they have higher unemployment rates overall than the United States.

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