The goal of the course is to make the students familiar with the economics of uncertainty and incomplete information and the basics of behavioral economics.

Part 1: Incomplete Information

• Student should know and understand the basic models and results associated to  moral hazard and adverse selection  (70s, early 80s)
• Students should be able to make their own small principal-agent models (screening / moral hazard) and be able to work out small extensions of those models.
• Students become accustomed to more recent topics in contract theory (e.g. dynamics, delegation).

Part 2: Behavioral Economics

• Students know and understand the basics of decision theory and neoclassical models of decision making under uncertainty and time discounting.
• Students know and are able to apply several non-expected utility models of decision making under uncertainty and models of time-inconsistent preferences.
• Students understand the challenges of modelling social preferences and are able to work with the several social preferences models.

The focus of the first part of the course is on asymmetric information market equilibria.

In the presence of asymmetric information market equilibria often fail to be Pareto optimal. Adverse selection arises when an informed individual's decisions depend on his privately held information that adversely affects uninformed market participants. Informed individuals may find ways to signal information about their unobservable knowledge through observable actions or uniformed parties may screen informed individuals. In case an individual hires another to take some action for him as his agent informational problems arise in this principal-agent setting from hidden actions (moral hazard).

This course focuses on screening and moral hazard. (Signaling and equilibrium refinements are covered in the course  RM Microeconomics 2). Topics which might be covered:

• Adverse selection
  • 2-type model, efficiency rent extraction trade-off, non-responsiveness (Laffont-Martimort, chap 2)
  • Type-dependent participation constraint, countervailing incentives, delegation, costly state-verification, repeated adverse selection (Laffont-Martimort, chap 3)
• Moral hazard
  • Two-action model, tradeoff between insurance and efficiency (Laffont-Martimort, chap 4)
  • Multi-tasking, nonseparability, application to financial contracts, collusion, mixed models (Laffont-Martimort, chap 5)
• More recent developments
  • Incomplete contracts / theory of the firm / verifiability
  • Delegation
  • Relationship contracting

 

The focus of the second part of the course is on individual decision making, and in particular on risk, time and social preferences.

After reviewing the neo-classical concepts, the course continues with behavioral insights. It will present  ecent decision making models and experimental evidence, and describe practical applications in different fields (finance, consumer protection, health care, etc.). Topics which might be covered are:

• Neoclassical decision making (choice, preference, utility, risk, stochastic dominance) 
• Criticisms on expected utility theory and empirical evidence
• Prospect theory, models of decision making under ambiguity
• Hyperbolic discounting 
• Preference for flexibility, temptation and self-control
• Models of other regarding preferences: inequity aversion, fairness ideals, reciprocity.