What is moral hazard? it refers to the actions people take before they enter into a transaction so as to mislead the other party to the transaction. it refers to the actions people take after they have entered into a transaction that makes the other party to the transaction worse off. it refers to the situation in which one party to a transaction takes advantage of knowing more than the other party to the transaction. it refers to the private, self-interested actions that people pursue, which when taken collectively leads to a loss in economic surplus.

You are the owner of a local honda dealership. unlike other dealerships in the area, you take pride in your “no haggle” sales policy. last year, your dealership earned record profits of $1.5 million. however, according to the local chamber of commerce, your earnings were 10 percent less than either of your competitors. in your market, the price elasticity of demand for midsized honda automobiles is 4.5. in each of the last five years, your dealership has sold more midsized automobiles than any other honda dealership in the nation. this entitled your dealership to an additional 30 percent off the manufacturer’s suggested retail price (msrp) in each year. taking this into account, your marginal cost of a midsized automobile is $11,000. what price should you charge for a midsized automobile if you expect to maintain your record sales?