Consider the following hypothetical scenario: a California study shows that prov

Question

Consider the following hypothetical scenario: a California study shows that providing free air conditioning for at-risk homes in the San Joaquin Valley from April 1 to October 1 each year will eliminate heat stroke, dehydration, and related ailments. However, opponents argue that subsidized air conditioning will lead those at-risk households to use far more air conditioning than they need to feel comfortable or to realize the health benefit. The term these opponents are using to describe this risk is “moral hazard.” Is their application of that term appropriate? Why or why not? If not, what outcomes might show “moral hazard”?

Explanation / Answer

Moral Hazard refers to a situation when one party takes risks knowing that the consequences of risks will be borne by some other party. In other words, the party alters her/his behaviour knowing that the finacial cost will be borne by some other party.

In this situation also, if at-risk homes are provided subsidized air conditioning, this will lead to more use of air conditioning than they need to feel comfortable as they know the cost is being borne by the government. So, the term moral hazard is appropriate for the situation as at-risk homes will get more indulged in taking way more than advantage from subsidized air conditioning knowing the cost is not borne by them.

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