The Concepts of Moral Hazard and Adverse Selection - Essay Example

The customers carry out things that the company doesn’t thus resulting in moral hazard.

Another example entails building contracts within the underlying building firm to construct a new headquarter. In this case, there is cost uncertainty thus firm will reimburse the prevailing builder for allowable costs and corresponding provisions for the normal rates of the return regarding the cost-plus contract (Sandler, 2001, 67-87). When the completion date for the contract is two years then adverse selection issues are the builder might be high cost and the cost-plus contract protect it. The moral hazard is that the contractor possesses no incentive to maintain the costs low under cost plus.

Solving the moral hazard problems in case the agents are risk neutral and possess unlimited liability is easy by disposing of the company. In cases where there is limited liability such as in bank loans or corresponding care concerning the risk, it is relatively harder to grant them incentives (Sandler, 2001, 67-87). Moreover, limited liability efficiency does not take place if not made by the investments.
Example of Pogouvian tax in everyday life
Pogouvian tax mainly caters to taxes and compensation regarding the external negative impacts. It entails tax and the corresponding duty of compensation that is produced coupled with social benefits (Barr, 2012, 241-9). For instance, the construction of factories far from town mainly attributes zero utility to the underlying factories’ duties but mainly defines antisocial aspects.

A firm producing a negative externality mainly pays its underlying marginal private cost and Pigouvian tax that is equivalent to the corresponding externality thus reducing its production regarding the socially optimal level of the output. This is because the firm would be reimbursing for the underlying damage caused to other personalities.
Correction of positive externality such as education is normally carried out by society subsidizing the consumer to increase the demand for the underlying commodities (Sandler, 2001, 67-87).

When the government subsidizes school loans it increases consumers’ demand for education. Moreover, a subsidy might grant the prevailing manufacturer to reduce the underlying marginal cost of offering the good. Governments sponsor educational institutions permitting them to charge a tuition rate that is less than the corresponding marginal private cost. Another example is when the government offers goods and services instead of the underlying private market (Khan, 2013.167-199). For instance, the majority of the prevailing education of K-12 is sponsored by the government with comparatively little direct cots to the corresponding students.

Example of Coase Theorem concept in everyday life

The coase theory is normally used in the determination of the transaction costs and coordination costs regarding the size of the firm (Barr, 2012, 241-9). Transaction costs are incurred within market exchanges that are as the underlying costs of transacting within the market exchange decrease relative to the corresponding coordination costs, firms normally tend to get smaller since it becomes less costly to attain the required services of factors of the production via a market exchange than the firm can bring the managers of those factors of production into the underlying set of associations of the firm. There are numerous reasons regarding the Coase theorem for the decrease in transaction costs namely the advancement of information technology. As computer hardware and corresponding software advance and as computer networking systems evolve and develop, the underlying cost of the search falls. This results in the creation of the boundaries of firms shrinking (Khan, 2013.167-199).

Conversely, advances in computer systems and networks result in a reduction of the internal costs of coordination in firms thus reducing the underlying cost (Sandler, 2001, 67-87). This makes Coase's theory to be ambivalent regarding the effects of advances in information technology on the underlying boundaries of the firms. Read More