Deutsch Intern
    Chair for Economics, Contract Theory and Information Economics (VWL7)

    Contract Theory

    During the 1960/70s, microeconomic theory came to acknowledge that many (if not most) economic transactions are characterized by asymmetric distribution of information – i.e., at least one of the parties participating in a transaction usually is privy to information that the remaining parties do not have access to. This asymmetric distribution of information subsequently was recognized to be a major impediment for transactions to be economically efficient. Contract theory addresses the question how the inefficiencies arising from asymmetric distribution of information can best be mitigated by appropriate design of the contractual (or, more generally, institutional) framework that governs the transaction under consideration.


    Course Outline

    This lecture covers the baseline models of ”moral hazard“ (i.e., situations where one party has private knowledge regarding its own actions) and “adverse selection“ (i.e., situations where one party has private knowledge regarding the economic environment of the transaction). Additionally, we will look into experimental evidence about actual human behavior in the situations described by the two models.

    Chapter 1: Moral Hazard

    • The Basic Model of Moral Hazard
    • Extension: Multiple Levels of Effort
    • Extension: Richer Performance Measure
    • Experimental Evidence: Hoppe & Schmitz (2018)

    Chapter 2: Adverse Selection

    • The Basic Model of Adverse Selection
    • Extension: Ex Post Private Information
    • Experimental Evidence: Hoppe & Schmitz (2015)



    Even though we will work with precise mathematical formalizations of the ideas that we want to think and talk about, this course requires little more than a solid understanding of basic differential calculus. More important than having a solid mathematical background is having a strong interest in formal economic analysis and fun with logical thinking and puzzle solving.  



    The following list compiles the primary references that the lecture draws upon. The readings in "The Theory of Incentives" are not meant to be mandatory – the lecture slides should be sufficiently detailed to guide you through the theoretical material that we are going to cover – but rather as voluntary for those who are interested in gaining additional related insights that go beyond the scope of this lecture. Several secondary references are provided in the lecture slides.

    Chapter 1: Moral Hazard

    • Chapter 4 in J.-J. Laffont und D. Martimort (2002), "The Theory of Incentives"
    • E. Hoppe and P. Schmitz (2018). "Hidden action and outcome contractibility: An experimental test of moral hazard theory", Games and Economic Behavior, 109, 544-564.

    Chapter 2: Adverse Selection

    • Chapter 2 in Chapter 4 in J.-J. Laffont und D. Martimort (2002), "The Theory of Incentives"
    • E. Hoppe and P. Schmitz (2015). "Do sellers offer menus of contracts to separate buyer types? An experimental test of adverse selection theory", Games and Economic Behavior, 89, 17-33.