Moral Hazard, Adverse Selection and the Optimal Consumption-Leisure Choice under Equilibrium Price Dispersion

Abstract

The analysis of the optimal consumption-leisure choice under equilibrium price dispersion discovers the methodological difference between problems of moral hazard and adverse selection. While the phenomenon of moral hazard represents the individual behavioral reaction on the marginal rate of substitution of leisure for consumption proposed by the insurance policy, the adverse selection can take place on any imperfect market under equilibrium price dispersion and it looks like a market phenomenon of a natural selection between consumers with different income and different propensity to search. The analysis of health insurance where the propensity to search takes the form of the propensity to seek healthcare demonstrates that moral hazard takes place when the insurance policy proposes a suboptimal consumption-leisure choice and the increase in consumption of medical services with the reduction of leisure time represents not an unlimited demand for “free goods” but the simple process of the consumption-leisure optimization. The path of consumerism with consumer-directed plans can solve partly the problem of moral hazard because in order to eliminate moral hazard this trend should come to the re-sale of medical services under health vouchers like it takes place in the life settlement.

Keywords

• moral hazard
• adverse selection
• consumption-leisure choice
• equilibrium price dispersion
• propensity to seek healthcare