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The Welfare Economics of Moral Hazard

In: Risk, Information and Insurance

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  • Richard Arnott
  • Joseph Stiglitz

Abstract

It is now widely recognized that the phenomenon of moral hazard, which arises whenever risk-averse individuals obtain insurance and their accident-avoidance activities cannot be perfectly monitored, is pervasive in the economy.1 Since individuals do not bear the full consequences of their actions, incentives for accident avoidance tend to be less than if they did. This, in itself, does not imply that the market is (constrained) inefficient; to establish inefficiency, it needs to be shown that there is some intervention in the economy that would lead to a Pareto improvement. The object of this article is to show that, in general, whenever moral hazard is present, market equilibrium is indeed “potentially” inefficient (i.e., assuming no costs of government intervention). The inefficiencies associated with market equilibrium with moral hazard take on a number of different forms, and here we provide a taxonomy of these market failures.

Suggested Citation

  • Richard Arnott & Joseph Stiglitz, 1991. "The Welfare Economics of Moral Hazard," Springer Books, in: Henri Loubergé (ed.), Risk, Information and Insurance, chapter 5, pages 91-121, Springer.
    • Handle: RePEc:spr:sprchp:978-94-009-2183-2_5
    DOI: 10.1007/978-94-009-2183-2_5
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