Question

Martha used to pay for her expenses with her own hard-earned money. She always tried to spend as little as she could. However, she started spending more when she received a scholarship. This behavior is an example of ________.

a. moral hazard.
b. a pecuniary externality.
c. the paradox of thrift.
d. the free-rider problem.

Answer 1

This behavior is an example of Moral hazard .

Option A

Explanation:

Moral hazard is a behavior occurs when a person increases his/her exposure to risk when insured or have a financial assistance. In this situation ''person takes more risks" because someone else is there to bear cost of risks. In the above situation, Martha used to spend less before but when she got the scholarship she started spending more as having a financial security of scholarship. Other options - pecuniary externality, the paradox of thrif and the free-rider problem are incorrect as do not have any relevance with the case of Martha.