🔍
Solutions to Moral Hazard - YouTube
Channel: Marginal Revolution University
[0]
♪ [music] ♪
[14]
- [Tyler] In the previous video,
[15]
we discussed how
asymmetric information
[17]
can lead to moral hazard,
[19]
which can lead
to people being ripped off,
[21]
which in turn can lead
to markets breaking down.
[24]
Now, there are two types
of potential solutions
[27]
to moral hazard problems.
[29]
First, since the problem
is asymmetric information,
[33]
you can try to make
information less asymmetric.
[36]
If both parties
have similar information,
[38]
then one party cannot
so easily exploit the other.
[42]
Second, if you can't get rid
of the information asymmetry,
[45]
you can try to reduce the incentive
of the agent to exploit
[49]
his or her informational advantage.
[52]
One example
that you're already familiar with
[54]
works along both
of these dimensions:
[57]
user ratings.
[58]
You can get ratings
for businesses at sites
[61]
such as Yelp and Angie's List,
[63]
and for products
at places such as Amazon.com.
[67]
Reviews give you more information
about a product or service,
[70]
and they help balance
the information
[72]
between buyer and seller,
[74]
thereby mitigating issues
of moral hazard.
[78]
Additionally, the existence
of these review sites
[81]
changes the incentives
for the sellers.
[83]
In our previous example
of the auto mechanic
[86]
we sketched out how your incentive
to get your car repaired
[89]
might conflict
with the mechanic's incentive
[92]
to milk you for extra money.
[94]
However, the mechanic also
has to think about her reputation,
[98]
which is what leads
to future business.
[101]
Previously, you might have told,
[103]
well, just a few friends
that you got ripped off.
[106]
Now, today, you can write
an online review
[109]
and reach a much larger audience,
maybe thousands of people.
[112]
A mechanic's online reputation
is important to her success
[116]
and provides an incentive
for her not to try to exploit
[119]
her informational advantage.
[122]
While review sites are great,
the market is continually evolving,
[126]
and some sellers try to fight back
[127]
by faking or manipulating
reviews or ratings.
[131]
There's some obvious examples,
[133]
like favorably reviewing
your friend's book on Amazon
[136]
if your friend reviews yours.
[138]
But there are more
subtle examples as well.
[140]
For instance, some universities
invite lots of applicants,
[144]
knowing they will reject them,
[146]
just hoping to boost
their rating for exclusivity.
[149]
Reviews are more trustworthy
if they come from third parties
[153]
who do not have incentives
to bias the review
[155]
one way or the other.
[157]
The magazine Consumer Reports,
for example,
[160]
has a reputation
for honest reporting
[162]
because it's a non-profit
and it accepts no advertisements
[166]
and no funding
from commercial sources.
[169]
But there's another problem --
[170]
it's hard to exclude people
from produced information.
[174]
Information is also
what we call nonrival --
[178]
nonexcludable and nonrival.
[180]
Do those property sound familiar?
[182]
Yes, information
has the characteristics
[185]
of a public good.
[187]
Click to go back
and review if you need.
[190]
It's hard for Consumer Reports
to keep the information it provides
[194]
to only those people
who buy the magazine.
[197]
If you hear that Consumer Reports
says that brand X of television
[201]
is the very best,
[202]
well you might use that information
[204]
even if you didn't buy
the magazine and pay for it.
[207]
In this case, we would say
that you are free riding,
[211]
using the benefits
of their research
[213]
and testing without contributing
to paying the costs.
[217]
Free riding is a problem, however,
not because it's unfair or unjust,
[221]
but because it means
that information provision
[224]
may be under-provided
in the first place.
[227]
As a result, there are fewer
trustworthy third parties
[230]
reviewing products and services.
[233]
So, review sites help solve
moral hazard issues
[236]
by both balancing the information
between buyer and seller,
[239]
and reducing the incentives
for the more informed party
[243]
to exploit
an informational advantage.
[247]
There are other approaches
[249]
that work solely
by modifying the incentives
[251]
of those people
with the informational advantages.
[255]
Let's take two examples
[256]
that might seem
completely different,
[258]
but are actually, conceptually,
pretty similar:
[261]
house inspections,
and second opinions from doctors.
[265]
When you buy a house,
you typically get a home inspector
[268]
to check out the house
and identify potential problems.
[271]
By law in many states,
[273]
these home inspectors
cannot also sell services
[276]
to fix any problems
they've identified.
[280]
This changes their incentives.
[281]
No longer do they have the incentive
[283]
to overstate
potential problem issues
[286]
to inflate the bill.
[287]
Similarly, when you go to a doctor
for a second opinion,
[290]
that doctor is simply
diagnosing the problem,
[293]
but not doing the actual treatment.
[295]
Just like with the home inspector,
[297]
this eliminates the incentive
to run up the bill.
[301]
Both of these examples
split the diagnosis of the issue
[304]
from the actual work
to address the problem.
[307]
So while the information
is still asymmetric,
[309]
there is less of an incentive
to exploit that asymmetry.
[314]
By the time you're ready
to fix the issue,
[316]
this separate diagnosis by an expert
[318]
allows you to have
much more information.
[321]
Maybe now, almost as much
as the service provider in some ways.
[326]
This video has covered
the various solutions
[328]
to moral hazard issues
[330]
in situations
of asymmetric information.
[333]
In the next video,
[334]
we'll take up
a different kind of response
[336]
to the asymmetric
information problem,
[338]
namely signaling.
[340]
See you then.
[342]
- [Narrator] If you want
to test yourself,
[344]
click "Practice Questions."
[346]
Or, if you're ready to move on,
just click "Next Video."
[349]
♪ [music] ♪
Most Recent Videos:
You can go back to the homepage right here: Homepage