AØKA08055U Contract Theory

Volume 2015/2016
Education

Elective at MSc in economics
MSc programme in mathematics-economics

Content

The course provides an introduction to contract theory. Contract theory examines the characteristics of optimal contracts when one party has certain relevant knowledge that the other party does not have.

The course consists of two parts. In the first part, some of the basic ideas in contract theory are presented. We will, in particular, look at optimal contracts when one party has hidden information (adverse selection) or can take a hidden action (moral hazard). In the second part of the course we apply the insights obtained to a number of specific economic questions, studying some original journal articles.

In the first part we will study selected sections of chapters 2-5 of the textbook by Laffont and Martimort. Chapter 2 explains the basic idea and insights of adverse selection. Chapter 3 studies some important extensions of the basic adverse selection model: for example, environments where the agent may be of more than two “types”, which may lead to “bunching” (i.e., several types being offered the same contract).

Chapter 4 explains the basic idea and insights of moral hazard, using a very stylized model with two effort levels and two possible outcomes. Chapter 5 extends this model in some interesting ways, for example: environments with a continuous effort variable, leading to a discussion of the so-called first-order approach.

The journal articles that we will study are about the political economy of industrial economics, and managerial incentives and product market competition.

Learning Outcome

The primary aim of the course is to introduce students to central results and insights in contract theory. An additional aim is to familiarize students with some selected examples of how contract theory can be used to study economic questions. A broader aim is that students who take the course will, by working extensively with theoretical models, acquire analytical skills that are transferable to other kinds of intellectual problems.

After having successfully completed the course the students will be able to formulate and solve contract theory models. The students will also be able to read professional journal articles that apply contract theory and to use this broad analytical approach when analyzing and thinking about questions where incentives play a role.

In order to pass the course, the student must demonstrate familiarity with and understanding of the approach of contract theory. Moreover, the student must show ability to solve and work with models used in contract theory and ability to understand the logic behind the results. The very good should at the end of the course be able to demonstrate full or almost full capability of using and understanding the techniques of analysis taught in the course.

Textbook: Laffont, Jean-Jacques, and David Martimort (2002), The Theory of Incentives: The Principal-Agent Model, Princeton University Press.

  • The Introduction (pages 1-6).
  • Sections 2.1-2.6, 2.9, 2.10 (except 2.10.2 and 2.10.3), and 2.15.2.
  • Sections 3.1 and 3.7.
  • Introduction to Ch. 4 (pages 145-148), Sections 4.1-4.4 up until and including Proposition 4.5 on page 161.
  • Section 4.5
  • Section 5.1.2
  • Sections 5.2.1 and 5.2.2.

We will also study selected journal articles.

Students will have to complete 4 projects consisting of several exercises. Of those 4 projects 3 must be passed in order to sit the exam.
No graduate courses are required, but it is recommended that a certain proficiency in solving game-theoretic models is achieved prior taking Contract Theory like in Micro C/Micro III at the Department of Economics. Students at the MSc of Economics programme can follow Contract Theory parallel with Contract Theory.”
Schedule:

The course consists of 2 hours of classes (lectures) every week 2x2 hours every second week for 14 weeks.

For enrolled students please find more information of courses, schedule, rules etc at
https:/​/​intranet.ku.dk/​economics_ma/​courses/​Pages/​default.aspx

Timetable and classroom:
Will be informed early May 2016
  • Category
  • Hours
  • Exam
  • 3
  • Lectures
  • 42
  • Theory exercises
  • 161
  • Total
  • 206
Credit
7,5 ECTS
Type of assessment
Written examination, 3 hours under invigilation
Individual written closed-book exam at the computers of Copenhagen University
Exam registration requirements

As a part of the course, three written assignments out of four should be completed and accepted.

Aid
Without aids
Marking scale
7-point grading scale
Censorship form
External censorship
100% censorship
Exam period

Will be informed early May 2016

Re-exam

Same as ordinary. But if only a few students have registered for the re-exam, the exam might change to an oral exams. This means that the examination date also will change.

For enrolled students more information about re-sit exam is available at https://intranet.ku.dk/economics_ma/examination/reesits/Pages/default.aspx

Criteria for exam assesment

The student must in a satisfactory way demonstrate that he/she has mastered the learning outcome of the course.