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In contract theory The first-best refers to the best you could do if you knew agents' preferences over labor an income (i.e., if you did not have to impose the incentive compatibility constraint), and the second-best is the best you can do if agents have to reveal their preferences themselves. In mechanism design A useful reference is Galichon, Alfred, Ex-...


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Just a model that can be used to state how (in)complete a particular contract is, whatever the reason. I remember a debate at the end of the 90's on Incomplete Contracts: Where do We Stand? by Jean Tirole and Foundations of Incomplete Contracts by Hart and Moore, where they develop a model that provides a rigorous foundation for the idea that contracts are ...


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Holmström and Milgrom assume that the agent exhibits constant absolute risk aversion. This implies that if you change the total wage of the agent with a lump sum transfer (that does not depend on effort), you will not change the incentives. Hence, to find the optimal contract, you can find the contract that maximizes total surplus subject to incentive ...


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To illustrate what Tirole has done, let's consider a simpler environment. Consider a utility maximisation problem over two goods, $x$ and $y$. The consumer has utility function $u(x,y) = f(x) + y$, where $f$ is strictly increasing and strictly concave. The consumer's problem is thus $$ \begin{align} \max_{x,y} &\quad f(x) + y \\ \text{s.t.} &\quad ...


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It is based on multiple pieces of work, most of which can be found in the prize committee's thoroughly referenced announcement.


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The solution to an optimal contract problem is called "first best" if it maximizes the principal's objective function subject to all constraints except the incentive constraints. The solution to an optimal contract problem is called "second best" if it maximizes the principal's objective function subject to all constraints, including the incentive ...


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An excellent (if slightly old) survey on the empirics of contracts can be found in Pierre-André Chiappori and Bernard Salanie (2003) "Testing Contract Theory: A Survey of Some Recent Work", in Advances in Economics and Econometrics, vol 1, M. Dewatripont, L. Hansen and S. Turnovsky eds, Cambridge University Press. It is mostly non-technical. Bernard ...


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First Best is the ideal optimal solution of a given problem, i.e. the mathematical solution of the model with "no imperfections". If that solution is not attainable then the solution must be binding to some constraint, in which case we call it a Second Best solution. 'Not attainable' here means that there's a discrepancy between the theoretical predictions ...


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In the above-mentioned quote, Oliver Hart is talking about a problem caused by incomplete contracts. Specifically, he is referring to the following paper: Hart, O., Shleifer, A. and Vishny, R.W. (1997). The proper scope of government: Theory and an application to prisons. Quarterly Journal of Economics, 112, 1127-1161. The incomplete contracting approach ...


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This looks like a case of incomplete contracts, or what is sometimes known as non-contractibility. In the principal/agent paradigm, adverse selection arises when an informed agent transacts with an uninformed principal and, in particular, the principal cannot distinguish between desirable and undesirable agent trading partners. I don't think your example ...


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I guess it depends on what precisely counts as "self-executing" but escrow transactions are very similar and quite common, particularly in real estate and certain kinds of online transactions. An escrow is a deposit of funds, a deed or other instrument by one party for the delivery to another party upon completion of a specific condition or event. It ...


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Not all principal-agent problems are the result of incomplete contracts, no. In fact, in most principal-agent problems, complete contracts are assumed. An incomplete contract is one that cannot be contingent on every possible outcome that could occur after the contract is signed. You can't write a contract that gives out a different payment to each party ...


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Since the authors state that the total labor input is: $$\int t_i(k)dk$$ the meaning of the total labor input in this case would be that it is the sum of all attention $t_i$ allocated over those tasks $k$. For example if we would assume that $t_i (k) = k$ then the labor supply across continuum given by $[0,1]$ would be equal to $\frac{1}{2}$ because $\int k ...


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Didn't manage to get to a definitve answer in one shot, but it seems to me that Jensen inequality is not going to help much. Build up: You are essentially asking that \begin{equation} E_v \left(u(a - v) \right) \leq E_c \left(u(a-c) |a\leq c \leq b\right) \end{equation} for a function $u$ increasing and concave and $[a, b] \subset Supp_v = [x,y]$. ...


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I suspect the $μ$ is introduced to account for the fact that no party can be forced to enter into a contract. Thus if we want to maximize the joint surplus that only works if both parties are willing to trade, and the parties are only willing to trade if it makes them both better off. Suppose you had a situation where the maximum joint surplus results in a ...


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