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An Adverse Selection Model with Finite Number of Types and Informational Rents

Author

Listed:
  • Daniela Elena Marinescu

    (Bucharest Academy of Economic Studies)

  • Ioana Manafi

    (Bucharest Academy of Economic Studies)

  • Dumitru Marin

    (Bucharest Academy of Economic Studies)

Abstract

In the paper we analyze a contractual relationship between two economic agents using a standard Principal-Agent approach from the theory of incentives. The Principal wants to delegate a production activity to an Agent privately informed about his marginal cost of production. This problem corresponds to a classical model of adverse selection. We first present the standard model with two types of agent and then we generalize it, assuming that the type of agent belongs to a finite set of values. We provide a full characterization of the Principal’s optimization problem and we solve it using Kuhn-Tucker techniques. Focusing on the economic interpretation of the optimal solution, we also use a change of variables. The optimization problem is next expressed in terms of the new variables, the informational rents. In the last part of the paper we derive and summarize the characteristics of the optimal contracts in the situation of asymmetric information.

Suggested Citation

  • Daniela Elena Marinescu & Ioana Manafi & Dumitru Marin, 2012. "An Adverse Selection Model with Finite Number of Types and Informational Rents," International Journal of Economic Practices and Theories, Academy of Economic Studies - Bucharest, Romania, vol. 2(3), pages 99-108, July.
    • Handle: RePEc:aes:ijeptp:v:2:y:2012:i:3:p:99-108
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    References listed on IDEAS

    as
    1. Baron, David P & Myerson, Roger B, 1982. "Regulating a Monopolist with Unknown Costs," Econometrica, Econometric Society, vol. 50(4), pages 911-930, July.
    2. Pierre-Andre Chiappori & Bernard Salanie, 2000. "Testing for Asymmetric Information in Insurance Markets," Journal of Political Economy, University of Chicago Press, vol. 108(1), pages 56-78, February.
    3. Baker, George P, 1992. "Incentive Contracts and Performance Measurement," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 598-614, June.
    4. Amy Finkelstein & Kathleen McGarry, 2006. "Multiple Dimensions of Private Information: Evidence from the Long-Term Care Insurance Market," American Economic Review, American Economic Association, vol. 96(4), pages 938-958, September.
    5. Claude Fluet & François Pannequin, 1997. "Complete Versus Incomplete Insurance Contracts under Adverse Selection with Multiple Risks," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 22(2), pages 81-101, December.
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    Cited by:

    1. Laura CONSTANTIN & Ștefan Virgil IACOB & Dana Luiza GRIGORESCU, 2021. "Financial contracts with several types of agents," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania / Editura Economica, vol. 0(3(628), A), pages 45-56, Autumn.

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    More about this item

    Keywords

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    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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