Adverse selection and moral hazard?

Question

can someone explain to me how adverse selection and moral hazard apply to an all-you-can-eat buffet?

Thanks!

Answer 1

Adverse Selection means attracting the 'wrong' type of people.

For a all-you-can-eat buffet, that would mean attracting people who can eat a lot, rather than people who can oly eat a little, since it's an 'all-you-can-eat'. People who can eat a lot find it cheap, people who can't eat so much find it expensive (they are full at a normal dinner which costs less, so why go for an all-you-can-eat?).

The trick to that is of course the pricing. Rather than taking the amount/value of what a normal person would eat, the buffet owner will have to take into consideration that his clientele would likely be made up of more big eaters than the average restaurant, and therefore price accordingly.

Moral Hazard means that the customer's behaviour can change.

In the caseof the all-you-can-eat-buffet, the small eater might decide that since he/she is paying for more food that he/she normally eats, then he/she will eat more than average, much more even. The all-you-can-eat therefore influences the behaviour of the consumer. This also applies to big-eaters who decide to have more than their usual too.

Therefore in pricing, the buffet owner must understand how the average cost per custonmer is affected by these 2 effects:
1 Adverse selection will mean the buffet attracts more big eaters than small eaters, so the portion eaten will be higher than in an average setting.
2 Moral Hazard will mean that many customers will tend to eat more than what they would eat, therefore teh average portion eaten would increase too.

The buffet owner therefore has to choose a price that reflects these two effects.

Answer 2

Ha, funny example.

Adverse selection in this case refers to the fact that it's primarily people who will eat more value of food than the cost of the buffet who will "select" themselves to eat at an all-you-can-eat buffet. People who don't eat much won't be seen there. So if eating at a buffet is voluntary, then the restaurant owner is in a no-win situation. He'll lose money.

Answer 3

Adverse selection:
The restaurant doesn't know how much you can eat when they agree on a price.
You don't know the quality or availability of food on the buffet when you agree on a price.

Moral Hazard:
You are best off eating as much as you can - even when the have eaten so much that the added value of the food you eat is less than the cost of the food to the restaurant.