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Game Theory by Mark L. Burkey

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Chapter 7

The Theory of Contracts

Introduction to Moral Hazard and Adverse Selection

In the first half of the book we usually assumed that the players had perfect information: everyone had all of the information available about the choices and payoffs. Similarly, in most basic economics courses we assume the same thing: We all know the quality of the products, the prices ­everyone is charging, and the productivity of our employees. However, there are many real-world situations where we do not know these things. Many of these complications are discussed in an area of economics called ­“principal–agent models,” or sometimes the “theory of contracts.”

The way we will explore this material is to set out the basic framework in this chapter and give ...

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