AN INTRODUCTION
TO THE ECONOMICS
OF INFORMATION
INCENTIVES AND CONTRACTS
Second Edition
Inés Macho Stadler
David Pérex-Catil
‘andatedy Rear Wat
OXFORDPREFACE
‘The eamomi of informations posbly th area of economic theory that has
coved most over the past ifteen years. Developed in paral withthe new
‘conomie of Industria Organieation, its importance and applications have
row spectacularly, objective isto study the situations in which agents
tempt to overcome thei ignorance about some relevant information by
taking decision designed to aequire new information a to avoid some of
the cost of thei ignorance When the infomation i asymmetrically ds
tributed among agents, these decisions involve the designing of contracts
intended to provide incentives andlor to indice the revelation of private
"This book consider stutonsin which asymmetric information exsin
contractual relationship, that sto a. in which one participant knows some
‘hing that another doesn. We aaieehremportant themes: moral azar,
‘adverse ston and sallng The models in which these themes ae studi
“llow sto explain aarge number of economic situations, eventhough we do
not analyse all the economic themes elated to information. Our choice is
‘based onthe ides of looking at only few themes bat in enough depth for our
readers to acquire acerain independence
“The book s organized inthe following way- There are ive chapters, the ast
threebeing deste tothe above-mentioned hemes In Chapter2 we present
‘he symmetric information station, the reference model, which serves 38.8
necessary starting-point to understand the effec ofeach of the informational
problems that ll. This chapter presents a base model in which the difer-
‘ent problems ar analysed. The homogencous nature ofthis model has the
advantage of allowing the ret tbe compared in simple and natural way.
‘The book begins with an introduction, in which the themes tbe studied ae
presented together with several examples tht show how te economics of in
ormation can be of interest
Hess the examples contained in the principal text ach chapter has de
tailed application of the models nd ther reals, In these supplement, we
resent simple models with lear economic messages rating to interesting,
nd current themes (finance insurance, ecology transfer, frm regulation,
publisubsiies et) Often. an application sa simplified version ofan article
published in ascentifc journal andcan be read quite independent fom thePreface
Imai text ofthe chapter This could be wsefal to those who peferto begin each
theme with rigorous presented example.
Each chapter also contains exercises of varying difcly,n oder that he
stadt can beep tak of his eel of leaing a well a srving a comple
rent tothe text Exercises of particular difficulty are marked with an asters
Tisneer easy to know if the best strategy fom an insractor point of view is
toincladetherlutions tothe exercises inthe same tx or not Since te exe
‘drs aeofen non-conventional, we have decided oincude the solutions a
‘the end of the book Finalh,the more formal aspects ofeach hapler ae rele-
sated to complementary materal sections
"The book designed tobe a one-semester undergraduate course ortobea
support tex fora doctorate cours on the subject. For thisreason, we were ws
sbletorevtthe temptation tonclude inthe thee central chaptrssetons on
‘vanced themes. These section do not present new model butraherarede
signed tobe a reading guide that we hope willbe uel the interested reader
aiid that canbe ignored for introductory course.
‘With especttothe eqired background knowledge tobe abeto follow this
introductory course on the Economics of Information, students who have
done baie courer of maths and micro-conomics should ind no dificlis
in falling this book. The text is xref in it treatment ofthe salations wo
constrained maximization problems, bu to resolve any doubts onthe theory
of maximization we include ashort appendix onthe Kuhn-Tucke method.
ACKNOWLEDGMENTS,
“This text was born from the lecture notes used during several academic
‘courses at the University of the Basque Country (Eusal Herrko
Uniberstate), and atthe Autonomous University of Barelona (Universitat,
‘Autonoma de Barcelona). The commento he students who worked on pre
liminary versions of thisbook hve contbuted0itsenrichment. There
‘tin the themes analysed as been the ving force behing the project. The
notesbeeame introduc aa Economia del Ijormacin, published by vil
Economia in 194, An Inrduction othe Economies of Information basically
‘the English trandaton ofthe Spanish version, wih some min revisions. We
regatta to Ariel Economia andi editor Marcelo Covi for their ep and
‘Support and to Oxford University Press and its editor Andrew Shullerforad-
‘ir and encouragement
‘Many colleagues have collaborated inthe provement ofthe nal version.
‘Weewould keto thank Paul de Bl Femando Branco, Antonio Cabrales, ose
vi
Preface
Maras Rocha, Marla Angele de Fos, a lvl Mate Pst Kiss
MERI oa Sobel ey red ener veins of the cuper and ge
TINS Sitiguerandsugrsions. We want fo cend our acknowl
seta eo whonrwe te xadenical indebted profes to
aarese ehom we have colored on ferent projets. Amongthe
Grae Stier artes nd Roger Guns deserve spec mention
“Mwai it acknowledge our debt colleague Rchard Wat who
var cnemous lp during te rpuratin ofthe Engl material fo i
Tone at wethan he DGICYT no. P9205, and Human Capital and
any projects ERBCHIXCT no, 20055 nd 930297 fr franca aid
Inde Macho Sar
eid Pérecaslo
aera Baral
Novomter 1985CONTENTS
Pre
1. Introduction
1, introduction
1.2, TheElements ofthe Problem
13. Thelnertemporal Development ofthe Relationship and
the Reference Bramework
14. Types of Asymmetric Information Problems
ALL Moral haa
TELE Adverse ston
143, Signaling
2, The Base Model
2.1, Introduction
2.2, Description ofthe Model
2.3, Symmetric Information Contacts
22.1. Theopima payment means
232 Theopimalleedof ort,
3, The Moral Hazard Problem
2. Introduction
5.2, The Moral Hazard Problem
33. The Agent Chooses betwen Two fort Levels
5.4 Soton Using the First Order Approsch
”
a
3
2Contents
2.5, ASimple Cas with Continous Ent °
3.6. Moral Hstard with Hidden Information st
3.7, Some Comments on the Simple Moral Hazard Models st
7. These of formsion =
373. Theses tects contacts se
174. What happens when itis the agent who ols the
3A. Complementary Material Pa
2A. A geomet ation ofthe morta problem 2
SA2, Thepotiem that maybe found when applying the fs
order approsch e
3A9, Thermo agent case a
3B, Applications 6
SIL, Incentive for managers “6
532. Fotingcontracts between ounce e
138. Mora bard and eatning in heat arhet a
SA. Invoduciono know bow intechnologywanserconacs 75
Emacs ”
SC, Advanced Themes w
4. The Adverse Selection Problem
a
SCL. Optimal pment mechanismsin stations of moral azar
thee aga e
302. Onpiationd deign ia liionshipewithecveslagents 92
SC, Moral based wih ever ta 4
SCH Repeated mora hard
SC, Reon between several principals andone agent >
441 traduction 103
42. AMode of Adverse Selection 106
443, When Principals Compete for Agents Ww
43.1 Thebenchmark: Smmetrcinfomaton ue
432. Prins cannot iting petty na
444, Adverse Selection with a Cotinoum of Posie Types Po
45. Comment 4
4A. Complementary Material 136
{12 Mean pt norman (rant cotact
cep)
48, Applications
{BL Compton ive ir compsi
‘82, Anamipssa opin eelngcotocs
‘3, Regain n ast ifomaton ones
{SRA Deekion of monopaty proc qulty
ries
AC. Advanced Themes
C1 Ratoni wither gens Actos
4C2 Orinion sgn
SC. Repeated arene ton
{4C. Malt mor haar and aden
{$C Sora prince
Signalling
5. tntedsction
5.2. The Value of Private Information and of Signalling
5.3. Education asa Signal
5 The Agents Signal thei Characteristic
Ss, Separating egiibvium
542, Foling guru
5.5. The Informational Power of Cont
5.1. Symmeticinfrmation
552. Theagentraninormed st diay of the job
S53, Seprsngequibra
536, Comments
453A. Complementary Material
SAL Theinutectieriam
5B, Applications
SB, Presthat signal qsity
52, Opinallicening contacts when the seer has pete
‘nfrmation
‘83, Debt level asgnal fea farm
209
210
a2
2”
29
x