Chapter 16: Moral hazard: Base models and two extensions
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We analyze the optimal contract in static moral hazard situations, where the agent’s effort is not verifiable. We first present the main trade-offs of the principal–agent model. We cover the trade-off of incentives (motivation) vs risk sharing (efficiency), incentives vs rents (when the agent is protected by limited liability), incentives to a task vs incentives to another (in a multitask situation), and incentives to the agent vs incentives to the principal (when both exert a non-verifiable effort). Then, we discuss two recent extensions: how incorporating behavioral biases in the analysis of incentives and inserting the principal–agent problem in a matching market affect the predictions of the classical moral hazard model.

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