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UPSC CSAT Tough Reading Comprehension 33 — The Problem of Moral Hazard: When Protection Changes the Risks People Take

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Sample Questions from UPSC CSAT Tough Reading Comprehension 33 — The Problem of Moral Hazard: When Protection Changes the Risks People Take

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Q1. Which one of the following best captures the central argument of the passage?

A. Protective arrangements generally encourage irresponsible behaviour because individuals no longer bear the full consequences of their decisions.

B. Moral hazard can be eliminated by ensuring that individuals and institutions bear all the financial consequences of their actions.

C. Protection against uncertainty is valuable, but because it changes incentives, institutions must balance meaningful risk-sharing with responsibility for avoidable harm while preserving socially beneficial risk-taking.

D. The principal purpose of insurance and public assistance should be to discourage risk-taking rather than compensate individuals for losses.

Q2. Which one of the following most accurately explains the concept of moral hazard as discussed in the passage?

A. A situation in which individuals deliberately conceal their existing risk characteristics before entering an insurance contract.

B. A situation in which protection against potential losses changes the incentives of the protected party, potentially influencing its subsequent behaviour.

C. A situation in which insurers refuse protection to individuals whose activities involve unusually high risks.

D. A situation in which individuals undertake risky activities because they systematically underestimate the probability of failure.

Q3. With reference to the passage, consider the following statements: 1. Moral hazard necessarily involves deliberate dishonesty or unethical intentions. 2. Insurance may encourage socially valuable experimentation by reducing the potentially catastrophic consequences of failure. 3. Information asymmetry can make it difficult for the party providing protection to monitor the behaviour of the protected party. 4. Eliminating all additional risk-taking after insurance is introduced is necessarily the most desirable policy objective. Which of the statements given above are consistent with the passage?

A. 1 and 3 only

B. 2 and 3 only

C. 1, 2 and 4 only

D. 2, 3 and 4 only

Q4. A farmer who previously avoided experimenting with improved seeds purchases crop insurance. The farmer subsequently adopts a promising but uncertain agricultural technique. The experiment occasionally fails, but successful harvests generate substantial productivity gains. Which inference is most consistent with the author's reasoning?

A. The farmer's increased willingness to experiment demonstrates that the insurance programme has created an undesirable moral hazard.

B. Insurance should be restricted to farmers who continue using established agricultural techniques.

C. The change in behaviour illustrates that protection can encourage socially valuable risk-taking, and the desirability of the arrangement depends on the benefits and costs of the resulting decisions.

D. The insurance programme cannot involve moral hazard because the farmer's intentions are productive rather than dishonest.

Q5. Which one of the following assumptions is most essential to the author's argument that expectations of government rescue may encourage excessive risk-taking by financial institutions?

A. Financial institutions generally prefer risky investments even when they must bear the entire consequences of failure.

B. The expectation of rescue can reduce the losses that decision-makers anticipate bearing if risky strategies fail, thereby influencing their choices before a crisis occurs.

C. Government rescue programmes always impose greater economic costs than allowing financial institutions to fail.

D. Managers of financial institutions are generally unable to estimate the probability of losses associated with their investments.

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