Cambridge International as and a level Economics Ebook

Paternalism: 
a situation where society knows best and has 
some right to make a value judgement.
KEY TERM
35
Chapter 1: Basic economic ideas and resource allocation

---

Scarcity and choice: 
Governments face the fundamental 
problem when deciding how to allocate their limited funds 
on what seem to be unlimited demands for public goods 
and merit goods. Choices have to be made as not all wants 
can be met. Choice should seek to maximise the benefits 
for all and not just a few people.
KEY CONCEPT LINK
TOP TIP
Merit goods are a controversial topic in microeconomics; 
not all economists recognise them as a type of good, 
arguing that they are a special case of information failure.
SELF-ASSESSMENT TASK 
1.9
Discuss, for your own economy, whether each of the 
following is a merit or a demerit good:
■
compulsory secondary education
■
wearing a seat belt
■
emergency health services
■
chewing 
gum
■
visiting a museum
■
playing loud music and shouting at a 
cricket match.
Moral hazard and adverse selection
Th
ere are numerous other examples arising from 
information failure. In welfare economics two types of 
situation can be recognised: 
moral hazard
and 
adverse 
selection
.
Moral hazard: 
the tendency for people who are insured or 
otherwise protected to take greater risks.
Adverse selection: 
where information failure results in 
someone who is unsuitable obtaining insurance.
KEY TERMS
Moral hazard can best be explained in the context of the 
health care market. Why does anyone go to a doctor? Th
e 
most usual reason is because we are not sure how to deal 
with a health problem, whether this is something trivial 
like a sore throat or something more serious. We visit the 
doctor to get information – in doing this we recognise 
that the doctor is better informed than we are and that the 
whole point about making this visit is to accept the advice 
that is given. Moral hazard is when some person in the 
market (in this case the doctor) is better informed than 
those seeking advice. However, if the advice is wrong, we 
shall have made an undesirable choice of treatment. Th
is 
will be a misallocation of resources.
Adverse selection is rather diff erent. In this case, 
the information failure is reversed because information 
may well be withheld or be inaccurate when it emanates 
from, say, someone requiring health insurance. Th
is puts 
the insurer in a position where not all the necessary 
information is provided for risk to be established. If this 
happens, then the cost of the health premium will be 
too low. If this person then requires treatment for an 
undisclosed problem, the premiums for healthy people 
will have to rise. In the worst case, if premiums become 
too expensive, healthy people may no longer seek health 
insurance as it has become too expensive. Th
is is not good 
news for the insurer who could be left only with ‘bad risk’ 
customers. It might even lead to the collapse of the market 
through the enforced withdrawal of insurers. Again, there 
is a misallocation of resources.