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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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    $\begingroup$ It's rational to work less harder, after you got a long term employment. So it's moral hazard. $\endgroup$ – Metta World Peace May 2 '15 at 8:28
  • $\begingroup$ @MettaWorldPeace How about paying doctor before the surgery? what is the possible explanation? $\endgroup$ – UnusualSkill May 2 '15 at 8:31
  • $\begingroup$ 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 Peace May 2 '15 at 8:38
  • $\begingroup$ @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? $\endgroup$ – UnusualSkill May 2 '15 at 8:42
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    $\begingroup$ 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. $\endgroup$ – Giskard May 2 '15 at 11:06
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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.

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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. $\endgroup$ – FooBar May 2 '15 at 12:17
  • $\begingroup$ @FooBar so in this case shd it be moral hazard or adverse selection? $\endgroup$ – UnusualSkill May 2 '15 at 12:39
  • $\begingroup$ @The Almighty Bob $\endgroup$ – UnusualSkill May 2 '15 at 12:39
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    $\begingroup$ @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. $\endgroup$ – The Almighty Bob May 2 '15 at 12:43
  • $\begingroup$ @UnusualSkill Both. $\endgroup$ – The Almighty Bob May 2 '15 at 12:44

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