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Endogenous Preferences and Dynamic Contract Design

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  • Zhang Wei

    () (Northern Illinois University)

Abstract

People's past decisions often play a significant role in shaping their future preferences. Based on this premise, we propose a model of endogenously changing preferences in an intertemporal environment. The two types of agents are distinguished by their self-knowledge of the dynamically inconsistent preferences. In particular, we study the dynamic contract design problem of a monopolistic principal in this setup. Commitment contracts and spot contracts are contrasted. When types are known to the principal, commitment contracts are superior to spot arrangements. When types are unobservable, we arrive at several unconventional results. First, the first best outcome can still be achieved in the case of commitment contracts. Second, informational externality may extend in both directions when the first best spot contracts are not incentive compatible. Lastly, in the second best spot contracts, informational rent may accrue to both types of agents.

Suggested Citation

  • Zhang Wei, 2012. "Endogenous Preferences and Dynamic Contract Design," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 12(1), pages 1-34, May.
  • Handle: RePEc:bpj:bejtec:v:12:y:2012:i:1:n:19
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    References listed on IDEAS

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    1. Patrick Bolton & Mathias Dewatripont, 2005. "Contract Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262025760, January.
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