Moral Hazard
Moral hazard occurs when an individual or firm changes behaviour after a transaction, taking greater risks because they are protected from the consequences. It arises when one party cannot monitor the other's behaviour, particularly in insurance and lending situations.
Real World
During the 2008 financial crisis, banks like Lehman Brothers took excessive risks partly because they expected government bailouts, meaning taxpayers rather than shareholders would bear the losses.
Exam Focus
Emphasise that moral hazard occurs after the transaction — this timing distinction separates it from adverse selection.
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