What is the difference between hidden information and moral hazard?
I cannot understand these two terms mainly. Please explain. Thank you.
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Hidden information concerns characteristics that are unobservable by one side of the market. For example, a consumer's willingness to pay, a worker's productivity, the quality of a used car all fall under this category. The characteristics in question are typically assumed to be fixed or very costly to modify.
Moral hazard concerns actions that are unobservable by one side of the market. For example, the effort that a CEO puts into managing a company and the care that an insured driver takes to maintain the condition of his car both fall under this category. By their very nature, the (unobservable) actions can be easily changed to suit the incentive structure of the problem.
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$\begingroup$ In moral hazard, effort is unobservable, okay. Well, in hidden information, type is unobservable? when I think the agent principal problem. Please expand the hidden information. I am confused hidden action. $\endgroup$ – b11bb Mar 14 '18 at 3:17
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$\begingroup$ What is the principal ‘s problem for these two especially for hidden information. $\endgroup$ – b11bb Mar 14 '18 at 3:20
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$\begingroup$ In fact I have onequestion. For hidden information, in the class, it is said that when does the agent learn his type? Two cases: post contractual And pre contractual. What I understand is that at first the agent does not know his own type. That is type is private info. according to contract signing time, the agent learn his type. If post contractual, agent learn his type after signing. if pre contractual, the agent learn his type before signing contract for example by interview or sitting a test etc. Right? $\endgroup$ – b11bb Mar 14 '18 at 3:35
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$\begingroup$ Sorry I asked too much question but I cannot understand the hidden information for the agent principal problem in fact. Thank you for helps. $\endgroup$ – b11bb Mar 14 '18 at 3:36
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$\begingroup$ @studying1234: I'm sorry but your comments are a little confusing for me. Whether the agent learns his type before or after signing the contract does not change the key features of hidden information: types are privately observable and cannot be changed, while actions are observable. $\endgroup$ – Herr K. Mar 14 '18 at 16:13
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In your basic introduction to information economics, the two classic interpretations of screening with hidden information correspond to monopolistic screening or a principal agent problem.
Viewing the situation through the lens of the principal agent problem; there is a firm who wants an agent to produce a good, and the agent has private information as to how costly it is to her to produce a good of a certain quality. That is there are multiple types of agents--if there is just one type, this is just the full information (first-best) case, and the screening problem is trivial. The producer's problem is to design a contract in order to maximize expected social value while minimizing the agent’s rent.
The basic problem with moral hazard, on the other hand, need not concern an agent with multiple types. Instead, the agent has multiple choices of effort. Now, the principal's problem is to choose the optimal level of effort and the best contract with which to elicit that effort level.
To sum up, in the hidden information (screening problem), there is an agent with a private type, and the principal designs a contract in order to maximize some objective, given this information asymmetry. In the moral hazard problem the principal chooses a contract in order to elicit the optimal level of effort.
Finally, as a caveat, this distinction is only clear at the introductory level, where the problems are very basic. One can easily have more complicated mechanism design problems that incorporate elements of both.
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Actually, in my course slides that the unique difference is that under hidden information, the principal's profit and effort of manager is one to ine, under moral hazard, the profit is unrelated to the effort of manager.
