Q3E Question:A major university bans... [FREE SOLUTION]

Chapter 17: Q3E (page 645)

Question:A major university bans the assignment of D or Fgrades. It defends its action by claiming that studentstend to perform above average when they are freefrom the pressures of flunking out. The universitystates that it wants all its students to get As and Bs.If the goal is to raise overall grades to the B level orabove, is this a good policy? Discuss this policy withrespect to the problem of moral hazard.

Short Answer

Expert verified

This policy will create the problem of moral hazard for the average and below-average students since they will not have an incentive to work harder to top the other students and not receive bad grades.

Step by step solution

Meaning of moral hazard

The moral hazard is a problem where the actions of one party incur a cost on another party that could not have been known before. For example, a person who gets a car insurance policy might engage in careless actions like over-speeding as the damage risk is insured. The actions of the buyer of the policy put a cost on the seller company, which the seller did not know at the time of selling the policy.

Explanation for the answer

Once the average and above-average students get the assurance that bad grades like D and F grades are not being given due to the said ban by the university, they will feel free from the pressure of scoring better grades. This can result in less hard work and degrading performance. Therefore, when such a policy is introduced, students who are average or above average, i.e., the ones who usually get As and Bs, will lose the incentive to work hard since lower grades no longer exist and receive higher grades anyway.

This policy has created the moral hazard problem since the management banned lower grades so that students get higher grades. At the same time, the loss of incentive actually results in a fall in performance, learning, and gaining knowledge (not expected by the management).