IDEAS home Printed from
MyIDEAS: Login to save this paper or follow this series

Moral Hazard and Efficiency in General Equilibrium with Anonymous Trading

  • Acemoglu, Daron
  • Simsek, Alp

A 'folk theorem' originating, among others, in the work of Stiglitz maintains that competitive equilibria are always or 'generically' inefficient (unless contracts directly specify consumption levels as in Prescott and Townsend, thus bypassing trading in anonymous markets). This paper critically reevaluates these claims in the context of a general equilibrium economy with moral hazard. We first formalize this folk theorem. Firms offer contracts to workers who choose an effort level that is private information and that affects worker productivity. To clarify the importance of trading in anonymous markets, we introduce a monitoring partition such that employment contracts can specify expenditures over subsets in the partition, but cannot regulate how this expenditure is subdivided among the commodities within a subset. We say that preferences are nonseparable (or more accurately, not weakly separable) when the marginal rate of substitution across commodities within a subset in the partition depends on the effort level, and that preferences are weakly separable when there exists no such subset. We prove that the equilibrium is always inefficient when a competitive equilibrium allocation involves less than full insurance and preferences are nonseparable. This result appears to support the conclusion of the above mentioned folk theorem. Nevertheless, our main result highlights its limitations. Most common-used preference structures do not satisfy the nonseparability condition. We show that when preferences are weakly separable, competitive equilibria with moral hazard are constrained optimal, in the sense that a social planner who can monitor all consumption levels cannot improve over competitive allocations. Moreover, we establish ε-optimality when there are only small deviations from weak separability. These results suggest that considerable care is necessary in invoking the folk theorem about the inefficiency of competitive equilibria with private information.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL:
Download Restriction: CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7821.

in new window

Date of creation: May 2010
Date of revision:
Handle: RePEc:cpr:ceprdp:7821
Contact details of provider: Postal: Centre for Economic Policy Research, 77 Bastwick Street, London EC1V 3PZ.
Phone: 44 - 20 - 7183 8801
Fax: 44 - 20 - 7183 8820

Order Information: Email:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Alberto Bisin & Piero Gottardi, 2005. "Efficient Competitive Equilibria with Adverse Selection," CESifo Working Paper Series 1504, CESifo Group Munich.
  2. Mikhail Golosov & Narayana R. Kocherlakota & Aleh Tsyvinski, 2001. "Optimal indirect and capital taxation," Working Papers 615, Federal Reserve Bank of Minneapolis.
  3. Alberto Bisin & John Geanakoplos & Piero Gottardi & Enrico Minelli & Heracles Polemarchakis, 2009. "Markets and Contracts," Working Papers 0915, University of Brescia, Department of Economics.
  4. Piero Gottardi & Belén Jerez, 2007. "Comment on "Bertrand and Walras Equilibria under Moral Hazard"," Journal of Political Economy, University of Chicago Press, vol. 115(5), pages 893-900, October.
  5. Jewitt, Ian, 1988. "Justifying the First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 56(5), pages 1177-90, September.
  6. Bel? Jerez, 2001. "A Dual Characterization of Incentive Efficiency," UFAE and IAE Working Papers 494.01, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  7. Timothy J Kehoe & David K Levine, 1993. "Debt Constrained Asset Markets," Levine's Working Paper Archive 1276, David K. Levine.
  8. Atsushi Kajii & Antonio Villanacci & Alessandro Citanna, 1998. "Constrained suboptimality in incomplete markets: a general approach and two applications," Economic Theory, Springer, vol. 11(3), pages 495-521.
  9. Alberto Bisin & Piero Gottardi, 1998. "Competitive Equilibria with Asymmetric Information," Levine's Working Paper Archive 2062, David K. Levine.
  10. Doepke, Matthias & Townsend, Robert M, 2004. "Dynamic Mechanism Design with Hidden Income and Hidden Auctions," CEPR Discussion Papers 4455, C.E.P.R. Discussion Papers.
  11. repec:oup:restud:v:54:y:1987:i:3:p:399-412 is not listed on IDEAS
  12. Bisin, A. & Guaitoli, D., 1998. "Moral Hazard and Non-Exclusive Contracts," Working Papers 98-24, C.V. Starr Center for Applied Economics, New York University.
  13. Citanna, Alessandro & Villanacci, Antonio, 2002. "Competitive equilibrium with moral hazard in economies with multiple commodities," Journal of Mathematical Economics, Elsevier, vol. 38(1-2), pages 117-147, September.
  14. Richard Arnott & Joseph E Stiglitz, 2010. "Randomization with Asymmetric Information," Levine's Working Paper Archive 2054, David K. Levine.
  15. Guesnerie,Roger, 1998. "A Contribution to the Pure Theory of Taxation," Cambridge Books, Cambridge University Press, number 9780521629560.
  16. repec:oup:qjecon:v:122:y:2007:i:2:p:487-534 is not listed on IDEAS
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:7821. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()

The email address of this maintainer does not seem to be valid anymore. Please ask to update the entry or send us the correct address

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.