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Introduction to contract theory - Adverse selection, moral hazard - Flashcards

(6 cards)

1
Q

Contract theory or “theory of incentives” :

A

Analyze relations between agents that have different information

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2
Q

Models of adverse selection, or hidden information :

A

Agent is characterized by a type (e.g. preference, productivity); Type is unobserved by the principa

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3
Q

Models of moral hazard, or hidden action :

A

Agent can make different actions (e.g. decide a level of effort)
Principal does not observe the action of the agent but only the outcome of the action

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4
Q

The problem of the regulator (= principal): maximize socialwelfare under the constraint that the firm participates :

A

max (t;q) : (S(q) − t)
s:t: t − θq ≥ 0
Constraint is what we call participation constraint (PC) or individual rationality (IR)

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5
Q

Offering those two contracts is not the best strategy for the regulator, both types choose the same contract, we have :

A

pooling (mutualisation)

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6
Q

Mussa-Rosen model :

A

If imperfect information, high type has an incentive to buy the low quality
Second best choice of qualities: lowest quality will be distorted (i.e. lower than under perfect information)

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