Advanced Microeconomics for Contract

by MacLeod

| ISBN: 9780262369473 | Copyright 2022

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A graduate textbook on microeconomics, covering decision theory, game theory, and the foundations of contract theory, with a unique focus on the empirical.

This graduate-level text on microeconomics, covering such topics as decision theory, game theory, bargaining theory, contract theory, trade under asymmetric information, and relational contract theory, is unique in its emphasis on the interplay between theory and evidence. It reviews the microeconomic theory of exchange “from the ground up,” aiming to produce a set of models and hypotheses amenable to empirical exploration, with particular focus on models that are useful for the study of contracts, institutions, and organizations. It explores research that extends price theory to the exchange of commodities when markets are incomplete, discussing recent developments in the field..

Topics covered include the relationship between theory and evidence; decision theory as it is used in contract theory and institutional design; game theory; axiomatic and strategic bargaining theory; agency theory and the class of models that are considered to constitute contract theory, with discussions of moral hazard and trade with asymmetric information; and the theory of relational contracts. The final chapter offers a nontechnical review that provides a guide to which model is the most appropriate for a particular application. End-of-chapter exercises help students expand their understanding of the material, and an appendix provides a brief introduction to optimization theory and the welfare theorem of general equilibrium theory. Students are assumed to be familiar with general equilibrium theory and basic constrained optimization theory.

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Contents (pg. vii)
Preface (pg. xi)
1. Introduction (pg. 1)
1.1 Price Theory (pg. 2)
1.1.1 Commodities (pg. 2)
1.1.2 Value (pg. 3)
1.1.3 The Welfare Theorems of General Equilibrium Theory (pg. 4)
1.2 Beyond Price Theory (pg. 6)
1.2.1 The Trade Price (pg. 6)
1.2.2 The Contract Price (pg. 8)
1.3 The Agenda (pg. 14)
2. Evidence, Models, and Decision Making (pg. 17)
2.1 Introduction (pg. 17)
2.1.1 "Superstition'' in the Pigeon (pg. 19)
2.2 Models for Representation (pg. 20)
2.3 Population Models (pg. 24)
2.3.1 The Mincer Wage Equation (pg. 26)
2.4 Causality (pg. 28)
2.5 Discussion (pg. 32)
2.6 Exercises (pg. 33)
3. Decision Theory (pg. 35)
3.1 Decision Making and the Economics Paradigm (pg. 35)
3.2 Behavior and the Rational Choice Model (pg. 36)
3.2.1 Is the Rational Choice Model Restrictive? (pg. 39)
3.2.2 Continuity of Preferences (pg. 40)
3.3 Risk (pg. 41)
3.3.1 Risk Aversion (pg. 46)
3.4 Uncertainty and Beliefs (pg. 49)
3.4.1 The Small World Model (pg. 50)
3.4.2 Preferences in the Face of Uncertainty (pg. 54)
3.4.3 The Value of Information (pg. 57)
3.5 Discussion (pg. 60)
3.6 Exercises (pg. 61)
4. Game Theory (pg. 65)
4.1 Introduction (pg. 65)
4.2 The Concept of a Strategy (pg. 67)
4.2.1 The Monty Hall Problem (pg. 71)
4.3 Rational Choice in a Game (pg. 73)
4.4 Nash Equilibrium (pg. 77)
4.5 The Problem of Commitment (pg. 79)
4.6 Sequential Equilibria and Other Solution Concepts (pg. 85)
4.6.1 Perfect Bayesian Nash Equilibria (pg. 86)
4.6.2 Subgame Perfect Nash Equilibria (pg. 87)
4.7 Repeated Games and the Payoff Possibilities Set (pg. 87)
4.7.1 Repeated Game Payoffs (pg. 88)
4.7.2 Repeated Game Strategies (pg. 91)
4.7.3 Cooperation in the Repeated Prisoner's Dilemma Game (pg. 92)
4.7.4 Characterization of the Payoffs in Repeated Games (pg. 95)
4.7.5 Infinitely Repeated Games (pg. 98)
4.8 Discussion (pg. 99)
4.9 Exercises (pg. 100)
5. Bargaining and the Buyer-Seller Model (pg. 103)
5.1 Introduction (pg. 103)
5.2 The Buyer-Seller Model (pg. 105)
5.3 Nash Bargaining Solution (pg. 107)
5.4 Contract Bargaining (pg. 111)
5.4.1 The Payoffs (pg. 112)
5.4.2 The Renegotiation Game (pg. 113)
5.4.3 Construction of the Bargaining Equilibrium (pg. 116)
5.4.4 Outside Options (pg. 118)
5.5 Discussion (pg. 124)
5.6 Exercises (pg. 126)
6. Reliance, Holdup, and Breach (pg. 129)
6.1 Introduction (pg. 129)
6.1.1 Contract Law and the Reliance Problem (pg. 131)
6.2 Production with Relationship-Specific Investments (pg. 133)
6.2.1 Characterizing Efficient Investment (pg. 135)
6.2.2 The Case of General Investments (pg. 138)
6.2.3 The Case of Relationship-Specific Investments (pg. 139)
6.3 Contracting for a Good (pg. 140)
6.3.1 The Contract Game (pg. 141)
6.3.2 Investment with No Ex Ante Contract (pg. 145)
6.3.3 Ex Ante Efficient Contract Design (pg. 147)
6.4 Contracting for a Service (pg. 152)
6.4.1 The Contracting Game (pg. 153)
6.4.2 Solving the Contract Game for a Service (pg. 154)
6.4.3 Holdup and the Standard Employment Contract (pg. 157)
6.4.4 Price and Wage Indexing (pg. 164)
6.5 Discussion (pg. 167)
6.6 Exercises (pg. 169)
7. Insurance and Moral Hazard (pg. 173)
7.1 Introduction (pg. 173)
7.2 Basic Agency Model (pg. 175)
7.3 Moral Hazard and Agency Theory (pg. 178)
7.3.1 Multiple Signals and Tasks (pg. 181)
7.3.2 The Lake Wobegone Effect: Penalties and the Probability of Detection (pg. 188)
7.4 Career Concerns (pg. 192)
7.4.1 Market Wage Determination (pg. 193)
7.4.2 Incentive Contracts with Career Concerns (pg. 196)
7.5 Discussion (pg. 197)
7.6 Exercises (pg. 200)
8. Trade with Asymmetric Information (pg. 205)
8.1 Introduction (pg. 205)
8.1.1 Trade with Asymmetric Information (pg. 207)
8.2 The Base Model (pg. 208)
8.2.1 Revelation Principle (pg. 210)
8.3 The Normative Evaluation of Allocations under Asymmetric Information (pg. 215)
8.4 Characterizing the Set of Incentive-Compatible Allocations (pg. 219)
8.4.1 The Set of Incentive-Compatible Allocations with Specific Performance (pg. 219)
8.4.2 Voluntary Exchange (pg. 225)
8.4.3 Implementing Ex Post Efficient Trade (pg. 228)
8.5 Power and Asymmetric Information: Monopoly and Monopsony (pg. 233)
8.5.1 Informed Seller and Efficient Monopoly (pg. 234)
8.5.2 Monopsony and Uber Economics (pg. 245)
8.6 Discussion (pg. 250)
8.7 Exercises (pg. 252)
9. Relational Contracts (pg. 257)
9.1 Introduction (pg. 257)
9.2 Breach and Contract Design (pg. 259)
9.3 The Production Environment (pg. 260)
9.3.1 Normal Commodities (pg. 262)
9.3.2 Innovative Commodities (pg. 263)
9.3.3 Discounted Expected Payoffs (pg. 263)
9.3.4 Feasible Allocations (pg. 264)
9.4 Relational Contracts with Symmetric Information (pg. 267)
9.4.1 Renegotiation (pg. 275)
9.5 Relational Contracts with Moral Hazard (pg. 278)
9.5.1 Contracts for Normal and Innovative Commodities (pg. 279)
9.5.2 The Market Mechanism and Efficiency Wages (pg. 281)
9.5.3 Efficient Relational Contracts with Moral Hazard (pg. 286)
9.6 Discussion (pg. 291)
9.6.1 What Is Reputation? (pg. 294)
9.7 Exercises (pg. 296)
10. Opportunism and Conflict in Agency Relationships (pg. 299)
10.1 Introduction (pg. 299)
10.2 A 2 × 2 Example (pg. 301)
10.3 Modeling Subjective Evaluation (pg. 306)
10.3.1 The Environment (pg. 307)
10.3.2 Contracts (pg. 308)
10.4 The Authority Contract (pg. 310)
10.4.1 Relational Contracts (pg. 314)
10.4.2 Efficiency Wage Contracts (pg. 317)
10.5 The Sales Contract with Subjective Evaluation (pg. 318)
10.5.1 Contracting with an Uninformed Principal (pg. 319)
10.5.2 Optimal Sales Contracts (pg. 322)
10.5.3 Opportunism and Contract Complexity (pg. 326)
10.5.4 Effort-Neutral Information Systems (pg. 327)
10.6 Discussion (pg. 329)
10.7 Exercises (pg. 333)
11. Summary (pg. 335)
11.1 Price Theory and the Role of Evidence (pg. 336)
11.2 Decision and Game Theory (pg. 338)
11.3 The Theory of Exchange (pg. 340)
11.4 Relational Contracts and Social Norms (pg. 346)
Appendix (pg. 353)
A.1 Constrained Optimization Theory (pg. 353)
A.2 Pareto Optimal Allocations in an Exchange Economy (pg. 355)
A.3 The Welfare Theorems of General Equilibrium Theory (pg. 358)
Notes (pg. 363)
Chapter 1 (pg. 363)
Chapter 2 (pg. 363)
Chapter 3 (pg. 364)
Chapter 4 (pg. 365)
Chapter 5 (pg. 366)
Chapter 6 (pg. 366)
Chapter 7 (pg. 368)
Chapter 8 (pg. 368)
Chapter 9 (pg. 369)
Chapter 10 (pg. 370)
Chapter 11 (pg. 371)
Appendix (pg. 371)
References (pg. 373)
Index (pg. 389)

W. Bentley MacLeod

W. Bentley MacLeod is Sami Mnaymneh Professor of Economics, Professor of International and Public Affairs, and Affiliated Law Faculty at Columbia University.

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