Theory of Incentives

The course reviews the main topics and models of the incentive theory. It begins discussing the problems that the design of incentives can pose in different economic environments and institutions (e.g. a worker/firm interactions, regulation of firms, design of governments). To study these problems,  it focuses on the principal-agent paradigm where a principal delegates an action to an agent. Both parties have different interests and information, and so the principal must provide the agent with incentives to take desired actions. The two major problems that arise in doing so are two major topics of this course: adverse selection and moral hazard. Adverse selection occurs when the agent learns some piece of information relevant to the contractual relationship, and moral hazard appears when the agent's actions are not observable. We study how the principal can optimally contract with the agent to provide incentives in these two settings. We discuss extensions of the basic framework to more complex environments as well as how to apply these concepts to other applications of incentive theory with multiple agents including auctions, team production, and design of voting systems.