I pay the doctor before he conducts the surgery.
Can anyone explain to me whether this statement shows moral hazard or adverse selection?
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1$\begingroup$ It's rational to work less harder, after you got a long term employment. So it's moral hazard. $\endgroup$– Metta World PeaceCommented May 2, 2015 at 8:28
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$\begingroup$ @MettaWorldPeace How about paying doctor before the surgery? what is the possible explanation? $\endgroup$– UnusualSkillCommented May 2, 2015 at 8:31
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$\begingroup$ You can't observe doctor's effort ex ante, so it's rational for a doctor to work at a level of effort that doesn't deserve his payment. You expect this, so you want to pay less. The doctor respond by shirking even more. This non-ending vicious cycle is adverse selection. $\endgroup$– Metta World PeaceCommented May 2, 2015 at 8:38
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$\begingroup$ @MettaWorldPeace Why cant I say it is a moral hazard since after paying the doctor, doctor(informed party) knows more about my condition and so may charge me more by recommending unnecessary procedures? $\endgroup$– UnusualSkillCommented May 2, 2015 at 8:42
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1$\begingroup$ To expand on Metta World Peace's comment: The answer depends on your model. Are there two types of doctors (honest and crooked) who put in effort accordingly (this is not a choice, it is determined by their work ethic), or is there only one type of doctor who decides his level of effort based on payment? In the first case you might have adverse selection, in the second you would have moral hazard. $\endgroup$– GiskardCommented May 2, 2015 at 11:06
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1 Answer
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The problem you are facing has probably both: Moral Hazard and Adverse Selection.
We have hidden action by the doctor (you can't really observe his level of effort during the surgery), therefore we have Moral Hazard.
Additionally, you (probably) can not know beforehand of the doctor is a good or bad doctor, so his type (good or bad) is unknown. So, there is hidden information and therefore possibly Adverse Selection. One example could be that a good doctor would never work for the amount you pay, so the doctor you hire is of the bad type.
Remark: I did not define good/bad doctor here, as it could be many different things; a bad doctor could just be a lazy doctor or a badly trained doctor.
answered May 2, 2015 at 11:42
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$\begingroup$ But you can observe the ex-post outcome, which correlates with the hidden action. As long as agents get a noisy signal, I don't think there is a moral hazard problem in a repeated game. $\endgroup$– FooBarCommented May 2, 2015 at 12:17
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$\begingroup$ @FooBar so in this case shd it be moral hazard or adverse selection? $\endgroup$ Commented May 2, 2015 at 12:39
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1$\begingroup$ @FooBar I don't see how the game here is repeated. And imho it is possible to have moral hazard with a noisy signal, depending on the rest of the model. $\endgroup$ Commented May 2, 2015 at 12:43
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