Glen's friend Andre is a big strong guy. Andre will not allow anyone to harm Glen. Glen enjoys teasing people. In fact, Glen's marginal benefit of teasing people is given by: MB(Q) = 75 - 10Q. Generally, people do not enjoy Glen teasing them
Thus, they retaliate to Glen's teasing. Without Andre around to protect Glen from the retaliation, Glen's marginal cost of teasing people is MC(Q) = 20Q due to the retaliation. However, with Andre around, Glen perceives his marginal costs of teasing to always be zero as no one will retaliate with Andre around. This is because Andre will step in to protect Glen from retaliation. Without Andre around, what is Glen's choice for teasing? How much does Glen increase teasing when Andre's around? Is Glen's behavior characteristic of a moral hazard or adverse selection?
Without Andre around, Glen will set: MB(Q) = MC(Q) ? 75 - 10Q = 20Q ? Q = 2.5. If Andre is present, Glen sets: MB(Q) = 0 ? 75 - 10Q = 0 ? Q = 7.5. Thus, Glen increases his teasing activities by 5 units. In this scenario, Andre is like an insurance policy for Glen. When Glen has his "insurance," he increases the activity that triggers payment by the insurer. Thus, Glen's behavior is characteristic of a moral hazard.
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