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Adverse Selection versus Moral Hazard Incentive Problem

WHich of the following is an example of an adverse selection problem and which is a moral hazard incentive problem? In each case, give one method that the restaurant might use to reduce the problem

1) A restaurant decided to offer an all-you-can-eat buffet that is sold for a fixed price. The restaurant discovers that the customers for this buffet are not its usual clientele. Instead the customers tend to have big appetites. The restaurant loses money on the buffet

2) A restaurant owner hires a manager who promises to work long hours. When the owner is out of town, the manager goes home early. This action results in lost profits for the firm.

3) An optional dental plan is offered to the employees of the restaurant. The restaurant pays 80% of the dental premiums. Employees who elect dental coverage pay the remaining 20% of the dental premiums. The costs of the employee dental plan have been skyrocketing 35% per year. In 2005, 79% of the employees chose dental coverage. In 2006, 59% of the employees chose dental coverage. In 2007, 39% of the employes chose dental coverage.

Solution Preview

1) This is an example of Adverse Selection problem. The restaurant, in this case, may allow only usual customers to have all-you-can-eat buffet or may charge higher prices for irregular customers.

2) ...

Solution Summary

Adverse Selection versus Moral Hazard Incentive Problem is posed.

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