introduction and adverse selection

Question 1

what is the 1st theorem of welfare economics

Answer 1

every walrasian (competitive) equillibrium is pareto efficient

Question 2

what is the second theorem of welfare economics

Answer 2

any pareto efficient allocation can be supported by a competitive equillibrium.

Question 3

what is an important underlying assumption for the 2nd theorem of welfare economics?

Answer 3

there is symmetric information, under asymetric information pareto efficient allocations are not commonly achieveable

Question 4

what is the two main types of information assymetry which occurs ex ante?

Answer 4

adverse selection and signalling

Question 5

what is the main type of information assymetry which occurs ex post?

Answer 5

moral hazard

Question 6

how to maximise the expected payoff under adverse selection?

Answer 6

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

Question 7

how to maximise the expected payoff under signalling?

Answer 7

the agent can signal his type to the principal, who observes the signals, updates her beliefs on the agent and offers corresponding contracts

Question 8

what is some examples of maximising the expected payoff under adverse selection?

Answer 8

mortage contracts, 3 for 2, data, sim plans etc

Question 9

what are examples of maximising the expected payoff under signalling?

Answer 9

education and advertising

Question 10

how to maximise the expected payoff under a moral hazard?

Answer 10

the principal needs to design incentive contracts as to induce the agent to exert more effort

Question 11

what is examples of maximising the expected payoff under moral hazard?

Answer 11

incentive packages for CEOs, scholarships for students

Question 12

when is a menu of contracts incentive compatible?

Answer 12

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_ )

Question 13

when is a menu of contracts incentive feasible?

Answer 13

a menu of contracts is incentive feasible if it satifies both incentive compatibility and individual rationality constraints

Question 14

what are the individual rationality constraints IC_ and IC^_?

Answer 14

t_ - θ_q_ >= t^_ - θ_q^_ (IC_)
t^_ - θ^*q^ >= t_ - θ^_ *q_ (IC^_)

Question 15

under assymetric info can the principal keep both agent types utility to be equal to zero when contract menu is incentive feasible, why?

Answer 15

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

Question 16

under complete information what is the cost of delegation>

Answer 16

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

Question 17

if P wants q^_ to be greater than 0, what must she provide to the θ_ type agent?

Answer 17

she must provide an information rent, the info rent generates from the agents information advantages over the principal

Question 18

what are the two components of the expected allocative efficiency under assymetric information?

Answer 18

the expect value is equal to the expected allocative efficiency minus the expected info rent

Question 19

what is the 2nd best allocation theorem?

Answer 19

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

Question 20

what does θ represent?

Answer 20

the agents marginal cost with low marginal cost represented by θ_ and high marginal cost represented by θ^_

Question 21

who knows the marginal cost θ of the agent under asymmetric information?

Answer 21

only the agent knows the marginal cost under asymmetric information

Question 22

when does the asymmetry occur during the contracting game?

Answer 22

the informaiton asymmetry occurs before the signing of the contract?

Question 23

what is the stages of the timing of a contracting game>

Answer 23

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

Question 24

what is the principals problem?

Answer 24

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