Explain the concept of moral hazard. Give an example. What ...

[vHAUNG6011]

Explain the concept of moral hazard. Give an example.
 
  What will be an ideal response?

Question 2

Do firms in perfect competition advertise their products? Why or why not?
 
  What will be an ideal response?

[duy1981999]

Answer to Question 1

Moral hazard exists when one of the parties to an agreement has an incentive after the agreement made to act in a manner that brings additional benefits to himself or herself at the expense of the other party. Moral hazard arises because it is too costly for the injured party to monitor the actions of the advantaged party. For example, Bob hires Jack as a salesperson and pays him a fixed wage. Jack has an incentive to put the least possible effort, benefiting himself and lowering Bob's profits.

Answer to Question 2

Firms in perfect competition do not advertise their product. The purpose of advertising is to increase the demand for the firm's product by convincing consumers that it's better than that of competitors. Perfectly competitive firms sell a standard product, so consumers won't believe that, for example, wheat sold by Farm A is somehow better than wheat sold by Farm B. So if a perfectly competitive firm advertised, this would only increase its costs, with no effect on demand and price.