Answer to Question #208885 in Microeconomics for Himanshu Negi

Question

How do inefficiency occur in the market due to externalities? Also, in what circumstance adverse selection and moral hazard different. Can one exist without the other?

Answer 1

I)Externalities stem from the production or consumption of goods or services, leading to costs or benefits for unrelated third parties. Externalities cause market failure, because the equilibrium price of a product or service cannot accurately reflect the true cost and benefit of the product or service

ii) The main difference is in the case of moral hazard, that is, the behavior of one of the parties changes after an agreement is reached. However, for the case of adverse selection, there is usually no symmetric information prior the transaction or contract is agreed.

iii) In most situations which never involve legal liabilities, insurance, warranties or any kind of obligation and continued contract, moral hazard is not likely to take place.