Contract Theory
During the 1960/70s, microeconomic theory came to acknowledge that many (if not most) economic transactions are characterized by asymmetric distribution of information – i.e., at least one of the parties participating in a transaction usually is privy to information that the remaining parties do not have access to. This asymmetric distribution of information subsequently was recognized to be a major impediment for transactions to be economically efficient. Contract theory addresses the question how the inefficiencies arising from asymmetric distribution of information can best be mitigated by appropriate design of the contractual (or, more generally, institutional) framework that governs the transaction under consideration.
This lecture covers the baseline models of ”moral hazard“ (i.e., situations where one party has private knowledge regarding its own actions) and “adverse selection“ (i.e., situations where one party has private knowledge regarding the economic environment of the transaction). As applications we will address questions discussed in personnel or industrial economics, such as incentive design within organizations or the design of competition laws.
Chapter 1: Moral Hazard
- The Basic Model of Moral Hazard
- Extension: Multiple Levels of Effort
- Extension: Richer Performance Measure
Chapter 2: Adverse Selection
- The Basic Model of Adverse Selection
- Extension: Ex Post Private Information
- Extension: Multiple Cost Types
Chapter 3: Contract Theory at Work in Personnel Economics
- Workplace Surveillance and Privacy Protection
Chapter 4: Contract Theory at Work in Competition Policy
- Price Discrimination in Input Markets
Prerequisites
Even though we will work with precise mathematical formalizations of the ideas that we want to think and talk about, this course requires little more than a solid understanding of basic differential calculus. More important than having a solid mathematical background is having a strong interest in formal economic analysis and fun with logical thinking and puzzle solving.
Literature
The following list compiles the primary references that the lecture draws upon. These readings are not meant to be mandatory – the lecture slides should be sufficiently detailed to guide you through the material that we are going to cover – but rather as voluntary for those who are interested in gaining additional related insights that go beyond the scope of this lecture. Several secondary references are provided in the lecture slides.
Chapter 1: Moral Hazard
- Chapter 4 in D. Martimort and J.-J. Laffont (2001), "The Theory of Incentives: The Principal-Agent Modell"
Chapter 2: Adverse Selection
- Chapter 2 in D. Martimort and J.-J. Laffont (2001), "The Theory of Incentives: The Principal-Agent Modell"
Chapter 3: Contract Theory at Work - Personnel Economics
- P. W. Schmitz (2005): "Workplace Surveillance, Privacy Protection, and Efficiency Wages ", Labour Economics, Vol. 12, p. 727-738
Chapter 4: Contract Theory at Work - Competition Policy
- F. Herweg und D. Müller (2014): "Price Discrimination in Input Markets: Quantity Discounts and Private Information", Economic Journal, Vol. 124, p.776-804
