An Introduction to the Economics of

This is a graduate textbook on the theory of contracting under asymmetric information, a key part of modern microeconomic theory. It examines the characteristics of optimal contracts when one party has certain relevant knowledge that the other party does not. The various problems are presented in the same framework to allow easy comparison of the different results. This updated second edition substantially extends the exercises that test students' understanding of the material covered in each section.

Ines Macho-Stadler is Associate Professor of Economics at the Universitat Autonoma de Barcelona. He gained his Ph.D. in Economics from the Ecole Hautes Etudes en Sciences Sociales (Paris).
J. David Perez-Castrillo is Associate Professor of Economics at the Universitat Autonoma de Barcelona. He gained his Ph.D. in Economics from the Ecole Hautes Etudes en Sciences Sociales (Paris).

Preface

vii

Introduction

3

(1)

The Elements of the Problem

4

(3)

The Intertemporal Development of the Relationship and the Reference Framework

7

(2)

Types of Asymmetric Information Problems

9

(8)

Moral hazard

9

(2)

Adverse selection

11

(1)

Signalling

12

(5)

The Base Model

Introduction

17

(1)

Description of the Model

17

(4)

Symmetric Information Contracts

21

(16)

The optimal payment mechanism

23

(5)

The optimal level of effort

28

(3)

Exercises

31

(6)

The Moral Hazard Problem

Introduction

37

(2)

The Moral Hazard Problem

39

(2)

The Agent Chooses between Two Effort Levels

41

(6)

Solution Using the First-Order Approach

47

(2)

A Simple Case with Continuous Effort

49

(2)

Moral Hazard with Hidden Information

51

(3)

Some Comments on the Simple Moral Hazard Models

54

(3)

The value of information

55

(1)

Mechanisms based on severe punishments

55

(1)

The strategic effects of contracts

56

(1)

What happens when it is the agent who offers the contract?

57

(1)

Complementary Material

57

(9)

A geometric illustration of the moral hazard problem

57

(6)

The problem that may be found when applying the first-order approach

63

(1)

The risk-neutral agent case

64

(2)

Applications

66

(21)

Incentives for managers

66

(2)

Fishing contracts between countries

68

(4)

Moral hazard and rationing in the credit market

72

(3)

Introduction of know-how in technology transfer contracts

75

(4)

Exercises

79

(8)

Advanced Themes

87

(16)

Optimal payment mechanisms in situations of moral hazard with several agents

87

(5)

Organizational design in relationships with several agents

92

(2)

Moral hazard with several tasks

94

(3)

Repeated moral hazard

97

(2)

Relationships between several principals and one agent

99

(4)

The Adverse Selection Problem

Introduction

103

(3)

A Model of Adverse Selection

106

(11)

When Principals Compete for Agents

117

(10)

The benchmark: Symmetric information

118

(3)

Principals cannot distinguish agent type

121

(6)

Adverse Selection with a Continuum of Possible Types

127

(7)

Comments

134

(2)

Complementary Material

136

(6)

Implementable mechanisms

136

(3)

Moral hazard with private information (ex ante contract acceptance)

139

(3)

Applications

142

(26)

Competition between insurance companies

142

(7)

An analysis of optimal licensing contracts

149

(4)

Regulation in asymmetric information contexts

153

(4)

Decision of monopoly product quality

157

(3)

Exercises

160

(8)

Advanced Themes

168

(17)

Relationship with several agents: Auctions

168

(4)

Organization design

172

(4)

Repeated adverse selection

176

(3)

Models of moral hazard and adverse selection

179

(1)

Several principals

180

(5)

Signalling

Introduction

185

(1)

The Value of Private Information and of Signalling

185

(4)

Education as a Signal

189

(1)

The Agents Signal their Characteristic

190

(9)

Separating equilibrium

193

(2)

Pooling equilibrium

195

(2)

Conclusion

197

(2)

The Informational Power of Contracts

199

(10)

Symmetric information

200

(1)

The agent is uninformed as to difficulty of the job

201

(1)

Separating equilibra

202

(7)

Comments

209

(1)

Complementary Material

210

(2)

The intuitive criterium

210

(2)

Applications

212

(12)

Prices that signal quality

212

(1)

Optimal licensing contracts when the seller has private information

213

(4)

Debt level as a signal of the value of a firm

217

(2)

Exercises

219

(5)

Advanced Themes

224

(7)

Equilibrium refinements

224

(2)

Cheap-talk games

226

(2)

Optimal design of mechanisms in signalling models

228

(3)

Mathematical Appendix: Concavity and Optimization

231

(6)

References

237

(8)

Solution to the Exercises

245

(30)

Index

275

(4)

Additional Exercises

279

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An Introduction to the Economics of Information Incentives and Contracts

Summary

Author Biography

Table of Contents

Supplemental Materials

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An Introduction to the Economics of Information Incentives and Contracts

Summary

Author Biography

Table of Contents

Supplemental Materials

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