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Moral Hazard

Moral Hazard

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Published by hishamsauk

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Published by: hishamsauk on May 01, 2011
Copyright:Attribution Non-commercial

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12/16/2012

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A
DVANCED
M
ICROECONOMIC
T
HEORY
 
M
ORAL
H
AZARD
Moral Hazard is a problem of 
hidden action
. In aprincipal-agent model, the principal cannot monitorthe agents actions directly, and so the agent can actwith full discretion.
In the following model,
the principal is a firm and theagent is worker.
T
he worker exerts a level of effort e, which the firmcant directly observe; all it can observe is output z,which is the sum of e and a stochastic randomvariable x.
he firm needs to offer a wage that will incentivize theworker to exert the optimal level of effort.
 
M
ORAL
H
AZARD
V
ariables:
ts.l of profiected leveil Shocks)to all (OObservable
exptheisitthenrandom,isiprelationshtheIf  effort,of functionaasrevenuesFirm'eP objective.sfirm'achievetoe'' effortemployingof costPersonaleC 0yE,xyyoutput,withcorrelated variablerandomExogenousy xezOutput,z 0xE, Noise''x LevelEfforte
!y!y!!!y!!y !!y!y
Convex functionConcave function

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