introduction and adverse selection Flashcards
what is the 1st theorem of welfare economics
every walrasian (competitive) equillibrium is pareto efficient
what is the second theorem of welfare economics
any pareto efficient allocation can be supported by a competitive equillibrium.
what is an important underlying assumption for the 2nd theorem of welfare economics?
there is symmetric information, under asymetric information pareto efficient allocations are not commonly achieveable
what is the two main types of information assymetry which occurs ex ante?
adverse selection and signalling
what is the main type of information assymetry which occurs ex post?
moral hazard
how to maximise the expected payoff under adverse selection?
the principle designs a menu of contracts targetting different types of agents and allows them to freely choose the contract preferred. it is otherwise called screenign
how to maximise the expected payoff under signalling?
the agent can signal his type to the principal, who observes the signals, updates her beliefs on the agent and offers corresponding contracts
what is some examples of maximising the expected payoff under adverse selection?
mortage contracts, 3 for 2, data, sim plans etc
what are examples of maximising the expected payoff under signalling?
education and advertising
how to maximise the expected payoff under a moral hazard?
the principal needs to design incentive contracts as to induce the agent to exert more effort
what is examples of maximising the expected payoff under moral hazard?
incentive packages for CEOs, scholarships for students
when is a menu of contracts incentive compatible?
a menu of contracts is incentive compatiable if agent θ_ weakly prefers (q_ , t_ ) to (q^_ , t^) and agent θ^ weakly prefers q^_ , t^_ ) to (q_ , t_ )
when is a menu of contracts incentive feasible?
a menu of contracts is incentive feasible if it satifies both incentive compatibility and individual rationality constraints
what are the individual rationality constraints IC_ and IC^_?
t_ - θ_q_ >= t^_ - θ_q^_ (IC_)
t^_ - θ^*q^ >= t_ - θ^_ *q_ (IC^_)
under assymetric info can the principal keep both agent types utility to be equal to zero when contract menu is incentive feasible, why?
no the principal is unable to achieve that if the contract menu is incentive feasible as by the θ_ type mimicking the θ^_ type, they can always achieve a strictly positive utility
under complete information what is the cost of delegation>
the cost of delegation is equal to zero as P achieves the same utility as if she carries out the task herself, all they need is to satisfy the IR constraint
if P wants q^_ to be greater than 0, what must she provide to the θ_ type agent?
she must provide an information rent, the info rent generates from the agents information advantages over the principal
what are the two components of the expected allocative efficiency under assymetric information?
the expect value is equal to the expected allocative efficiency minus the expected info rent
what is the 2nd best allocation theorem?
under asymmetric information, the optimal contract menu entails:
- no output distortion for the efficient type θ_ and the inefficient type θ^_ produces less than in the 1st best allocation
- only θ_ type gets a positive information rent
what does θ represent?
the agents marginal cost with low marginal cost represented by θ_ and high marginal cost represented by θ^_
who knows the marginal cost θ of the agent under asymmetric information?
only the agent knows the marginal cost under asymmetric information
when does the asymmetry occur during the contracting game?
the informaiton asymmetry occurs before the signing of the contract?
what is the stages of the timing of a contracting game>
in time period 0, the agent discovers his marginal cost type θ, in time period 1 the principal offers a contract, in time period 2, the agent either accepts or refuses the contract,. in time period 3, the contract is executed
what is the principals problem?
to maximise their expected value S(q) - t subject to the constraint of the agents utility function t - θq where t is the transfer to the agent, q is the output, θ is the margianl cost to the agent and S(q) is the valuation of output
