The problem of aligning the interests of the principal (such as voters) and the agent (such as elected officials).
Principal-Agent Problem: The Principal-Agent Problem refers to the issue of aligning the interests of two parties – the principal, who delegates authority, and the agent, who carries out the delegated task – in situations where the two parties have different objectives and incentives.
Agency Costs: The costs incurred by a principal in monitoring and controlling an agent to ensure that the agent acts in the interests of the principal.
Moral Hazard: The problem of hidden actions or moral hazard arises when the agent has an incentive to act in a way that is detrimental to the principal since the agent bears the cost of the action, but the principal bears the consequences.
Information Asymmetry: The situation in which one party has more or better information than the other party is referred to as information asymmetry. When it comes to the Principal-Agent Problem, the agent may hold more information than the principal.
Incentive Design: Incentive design is the process of setting up a system that motivates agents to work in the best interests of the principal.
Contracting: Contracting involves the use of written agreements and contracts to stipulate the conditions and responsibilities of the parties involved in a Principal-Agent relationship.
Principal-Agent Model: A Principal-Agent Model is a mathematical model describing the relationship between the Principal and Agent, including the goals, allocation of resources, and actions taken by each.
Mechanism Design: Mechanism Design involves the design of optimal contracts, rules, or institutions that result in outcomes that align well with the interests of the principal in a Principal-Agent relationship.
Shirking: Shirking refers to the act of the agent not exerting the optimal effort required to fulfill their obligations to the principal.
Moral Suasion: A method of monitoring and controlling agents that is not based on formal enforcement mechanisms, but instead relies on the use of social norms, moral persuasion, and other forms of informal control.
Incentive Compatibility: Incentive compatibility occurs when the incentives provided to agents in a Principal-Agent relationship align with the goals of the principal, thereby ensuring that the agents choose the optimal level of effort or action.
Prisoner’s Dilemma: A game theoretical model where two players act in their own best interests, leading to a suboptimal outcome for both, known as the Nash Equilibrium.
Adverse Selection: Adverse selection occurs when one party has more information than the other party in a Principal-Agent relationship, which can lead to an unfair allocation of resources or moral hazard problems.
Signaling: Signaling is the process of conveying information to others about one’s intentions, abilities, or motivations, even if it is not beneficial to the person sending the signal.
Social Contract: The social contract is a theoretical concept explaining the relationship between an individual, the state, and society. It describes the trade-offs necessary for individuals to live in a collective society, including issues related to incentive alignment, monitoring, and control.
Adverse Selection: A situation where an asymmetric information arises between the principal and the agent, as the agent has more information than the principal. The agent can take advantage of this information and provide suboptimal services, resulting in a negative impact on the principal.
Moral Hazard: A situation where the agent's incentives are not aligned with the principal's goals, leading to suboptimal performance. For instance, an insurance policyholder may not take measures to prevent accidents since the insurance company will pay the medical bills.
Free Riding: A situation where an agent can benefit from the actions of another agent, without contributing to the cost. This problem is common in public goods situations such as public transportation, where an individual who can ride on another's bus-pass without paying contributes to free riding.
Shirking: A situation occurs when an agent chooses to engage in low-quality work or prefers to be free-riding, rather than fulfilling its responsibilities on behalf of the principal.
Hold-up Problem: A situation where an agent makes excessive demands when the principal cannot easily switch to other available agents to finish the task.
Double Marginalization Problem: A situation where both parties in a negotiation have a monopoly's effect on tariffs or taxation, which results in double marginalization. The double marginalization problem leads to an increase in the price of the goods or services, leading to inefficiencies in terms of market and economic expansion.
Principal-Agent with Split Incentives: A situation where the agent can benefit from outcomes that are harmful to the principal, leading to market failures. In such cases, introducing proper regulations and incentives-based mechanisms can help reduce moral hazards.
Ex Post and Ex Ante: A situation that occurs concerning the timing of adverse selection and moral hazard. The ex post problem occurs after the agent has been hired or after the contract's execution, whereas the ex ante issue occurs before the signing of the contract.
Communication Problems: A situation that arises when the communication between the principal and agent is inadequate, leading to suboptimal results. For example, in debt contracts, communication is essential, while a lack of communication leads to a lack of trust or incentives.
Lattice Device: A situation where an agent's inefficiency and negative outcomes occur because some specificity-or-device-based constraints prevent better or more efficient agents from substituting, acting as a hurdle for the principal or agent in the market.