Lecture 5

Question 1

do managers’ interests always align with owners?

Answer 1

no

Question 2

asymmetric information = ?

Answer 2

one party has information that the other party does not

Question 3

who is the principal/agent between manager and owner or manager and owner?

Answer 3

manager (principal), student (agent)

owner (principal), manager (agent)

Question 4

how is one determined as the principal or agent?

Answer 4

the agent can impact the principal’s payoffs through their actions

the agent has hidden actions/attributes

Question 5

how is hiring people different from purchasing goods/services?

Answer 5

humans can have hidden actions e.g., laziness, unproductive output etc.

no guarantee of performance level nor is it controllable

Question 6

incomplete contract = ?

Answer 6

incomplete contract doesn’t specify the rules regarding every little aspect of the deal

Question 7

why do workers work hard?

Answer 7

work ethic
feelings of responsibility (morality)
gratitude
fear of being fired
promotion
commission

Question 8

can traders easily verify quality with incomplete contracts?

Answer 8

no

if they can observe quality, it wouldn’t be verifiable in court

(e.g., employee work ethic can’t be weaponised in court as it can’t be proven)

Question 9

exogenous enforcement of contract = ?

Answer 9

a contract enforced by the court or another third party

Question 10

what two things do all contracts involve? (both complete and incomplete contracts)

Answer 10

mutual gain and conflict of interest

Question 11

mutual gain = ?

Answer 11

both parties profit from the transaction

Question 12

conflict of interest = ?

Answer 12

either one or both parties are settling to a certain extent

Question 13

endogenous enforcement of contract = ?

Answer 13

when parties to an exchange adopt strategies to derive favourable payoffs

these strategies involve aspects of the contract that aren’t specified

Question 14

example of endogenous enforcement of contract?

Answer 14

employee working minimally for maximum pay as it’s not specified how productive they should be

Question 15

how do principals ensure endogenous enforcement of contract is prevented?

Answer 15

incentivise people to act in a certain way either by providing benefits for certain actions or instilling fear with threats

Question 16

endogenous = ?

Answer 16

in house, under-the-table

finding loopholes

Question 17

verifiable information = ?

Answer 17

information that can be used in court of law to enforce a contract

Question 18

non-verifiable information = ?

Answer 18

information that can not be used in court of law and isn’t enforceable in a contract

Question 19

what are reasons for contractual incompleteness?

Answer 19

asymmetric information
time
measurability
authority
motivation

Question 20

principal-agent problem is also known as …?

Answer 20

the agency problem

Question 21

contingent on = ?

Answer 21

something is dependent on something

Question 22

moral hazard = ?

Answer 22

when an agent might perform hidden actions that are unenforceable and indicate they’re not holding up their end of the deal

immoral

Question 23

employer/worker, who’s the principal/agent?

Answer 23

employer is principal
worker is agent

because employer’s payoffs are dependent on worker who may have hidden actions (laziness) or attributes (incompetence)

Question 24

what goods/services are being exchanged between an employer and an employee?

Answer 24

labour services

Question 25

what strategy does the employer use to derive favourable payoffs?

Answer 25

contingent renewal of employment (risk of firing)

Question 26

lemon = ?

Answer 26

car that is potentially defective

Question 27

peach = ?

Answer 27

car that turns out to be better value than what it was bought for

Question 28

mutual benefit from exchange = ?

Answer 28

willingness to buy from buyer - willingness to sell from seller

Question 29

sellers who realise the market value is less than the actual value of their product…?

Answer 29

will leave the market

Question 30

sellers will refuse to sell if buyers aren’t willing to pay…

Answer 30

over half the actual value of the product

Question 31

lemons problem = ?

Answer 31

buyers are principals and sellers are agents

sellers (agents) have hidden attributes/actions that can impact the buyer’s payoffs

e.g., the car might be rubbish and worth less than what it’s being sold for

Question 32

adverse selection = ?

Answer 32

a problem for a principal who lacks information on relevant attributes of an agent which leads to the principal offering poorly causing the agent to drop out

Question 33

which factors could disarm the lemon problem?

Answer 33

quality assurance boards/mechanisms

legislation from third parties as a penalty for poor product/service provision

Question 34

in the benetton model, who’s the principal/agent out of patrisia/armin (buyer and seller)

Answer 34

buyer is patrisia, she is the principal

agent is armin, as he’s the seller who may have hidden actions/attributes regarding the product (e.g., its quality/value)

Question 35

what gives rise to the principal agent problem?

Answer 35

conflict of interest

the quality of the product can’t be determined, so buyer doesn’t know the calibre of the product they’re buying

Question 36

how can a buyer determine the quality of products they’re purchasing?

Answer 36

have a repeated relationship

termination probability

enforcement rent (pay good amount)

Question 37

the level of quality the agent supplies…

Answer 37

depends on how valuable it is to the agent to continue the relationship with the principal

Question 38

disutility = ?

Answer 38

causing inconvenience

Question 39

utility = ?

Answer 39

term used to determine the worth/value of goods/services

Question 40

ICC = ?

Answer 40

incentive compatibility constraint