Market Failure as a Consequence of Hidden Actions
Hidden-action problems result in market failure. This failure stems from the agent's decision-making, where their actions impose an external benefit on the principal but incur a private cost to themselves, leading to an inefficient outcome. [1]
0
1
Tags
Social Science
Empirical Science
Science
CORE Econ
Economics
Economy
The Economy 2.0 Microeconomics @ CORE Econ
Ch.10 Market successes and failures: The societal effects of private decisions - The Economy 2.0 Microeconomics @ CORE Econ
Introduction to Microeconomics Course
Related
Differentiating Negligence from Bad Luck in Insurance Claims
Incentive Alignment as a Partial Solution to Hidden-Action Problems
Moral Hazard in Labor Markets
Contractual Limits in Insurance to Mitigate Moral Hazard
Incompleteness of Insurance Contracts due to Hidden Actions
Market Failure as a Consequence of Hidden Actions
A company hires a remote salesperson on a fixed monthly salary to generate new leads. The number of successful leads generated depends on both the salesperson's effort in making calls and researching clients, as well as external factors like the overall economic climate and competitor actions. The company cannot directly monitor the salesperson's day-to-day activities. Why does this arrangement present a hidden action problem?
Insurance and Risky Behavior
Government Bailouts and Future Risk
A health insurance company notices that individuals who are more likely to need extensive medical care are the ones most eager to purchase its comprehensive insurance policies. This situation is a classic example of a hidden action problem.
Analyzing Performance Under Uncertainty
Match each scenario with the description that best explains whether it represents a hidden action problem.
Evaluating Solutions to Moral Hazard in Unemployment Benefits
In a hidden action problem, the presence of ______ makes it difficult for one party to determine whether a negative outcome was caused by the other party's unobservable behavior or by factors beyond anyone's control.
A driver purchases a full-coverage auto insurance policy. Arrange the following events to illustrate the logical progression of a hidden action problem from the insurer's perspective.
Evaluating CEO Compensation Structures
Moral Hazard as a Challenge for Home Price Insurance
Designing an Employment Contract to Mitigate Hidden Actions
A company hires a remote salesperson and offers them a fixed monthly salary, with no performance-based commissions. The company cannot easily monitor the salesperson's day-to-day effort. Which of the following outcomes is the most direct consequence of this information arrangement?
When an insurance company offers a policy, it cannot know for certain whether a policyholder will engage in risky behaviors after purchasing the coverage. This situation, where one party's actions post-agreement are unobservable to the other, is an example of a __________ problem.
Origin of the Term 'Moral Hazard' in Insurance
Divergence of Social and Private Benefit in Principal-Agent Problems
The Inefficiency of Insured Behavior
Inefficiency in the Rental Market
A company owner pays a manager a fixed salary to run a new project. The project's success depends on both the manager's effort and random market factors. The owner cannot directly observe the manager's level of effort. The manager, knowing this, chooses to exert low effort because high effort is personally costly and does not increase their fixed salary. This leads to a lower probability of the project's success. Why is this outcome considered Pareto inefficient?
Insured Driver's Risky Behavior
Role of External Uncertainty in Hidden-Action Problems
The Labour Discipline Model as an Example of External Effects
External Effects in Insurance Markets
Information Imbalance as an External Effect
In a market where sellers have private information about the quality of the product they are selling (a 'hidden attribute'), the presence of low-quality goods can reduce the price that buyers are willing to pay for any good, regardless of its actual quality. Why does this information imbalance represent an external effect?
Match each economic scenario with the term that best describes the underlying information problem which creates an external effect.
In a situation characterized by hidden actions, the resulting external effect arises because one party possesses unobservable characteristics before entering into an agreement, which negatively impacts the other party.
Analyzing Externalities from Hidden Actions
Evaluating Market Failure from Asymmetric Information
Evaluating a Policy Response to Hidden Actions
A firm hires a remote employee whose effort level cannot be perfectly monitored. The employee chooses to exert less effort than the firm expects, resulting in a lower-quality output. How does this scenario represent an external effect caused by asymmetric information?
Evaluating Policies to Address Information Asymmetry in the Restaurant Industry
Comparison of Hidden-Action Problems with Other Externalities
Market Failure as a Consequence of Hidden Actions
Learn After
Inability to Purchase Full Insurance as a Market Failure
Exclusion from Profitable Investments due to Lack of Collateral
Analyzing Inefficiency in a Service Contract
A company hires a salesperson on a fixed salary to sell a product. The salesperson's effort level, which directly impacts sales volume, is costly to the salesperson and cannot be perfectly monitored by the company. This often results in the salesperson exerting less effort than the level that would maximize the company's profit. Which of the following statements best analyzes the fundamental reason for this inefficient outcome?
Analyzing Inefficiency in an Agricultural Contract
The Externality of Hidden Actions
Consider a situation where a landlord cannot perfectly observe the level of care a tenant takes with a rental property. The tenant bears the full private cost of any extra effort to maintain the property (e.g., time spent cleaning, being careful with appliances). True or False: This situation leads to an economically efficient level of property maintenance because the tenant directly benefits from living in a well-maintained apartment, aligning their incentives with the landlord's interest in preserving property value.
A publicly-traded company's shareholders hire a CEO to maximize the firm's value. The CEO can choose to exert high effort (working long hours, pursuing difficult innovations) or low effort (maintaining the status quo). The CEO's effort level is costly to them in terms of time and stress, and it is difficult for the thousands of dispersed shareholders to monitor accurately. The high effort would likely increase the company's profits and stock value, benefiting the shareholders.
Based on this hidden-action scenario, match each component of the economic model to its correct description.
In a scenario involving unobservable effort, market failure occurs because the action that benefits one party incurs a ______ ______ for the individual performing the action, leading to an inefficiently low level of that action.
Arrange the following statements into the correct logical sequence that explains how a hidden-action problem leads to market failure.
Analyzing Market Failure in Venture Capital
A team of software developers is rewarded with a bonus that is shared equally among all members based on the overall success of a project. The manager cannot perfectly observe the individual effort each developer contributes. This often results in a lower total effort and a less successful project than is potentially achievable. Which statement best analyzes this situation as a market failure stemming from a hidden action?
Analyzing Inefficiency in an Agricultural Contract
The Externality of Hidden Actions