ECON 401 Lecture Notes - Lecture 26: W. M. Keck Observatory
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ECON 401 Full Course Notes
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Exogenous information is known to one side of the market, but not the other. : quality of a car, accident probability, labor productivity. Endogenous action is observed by one side of the market, but not the other. : employee"s work effort; bank"s effort to check the quality of mortgage applicants. An employer (the principal) hires an employee (the agent) to undertake some task. The revenue generated by the employee"s effort can be observed. Low revenue may be due to lack of effort, or due to bad luck. The principal proposes a contract: a desired effort level (low or high) a wage if the revenue is low a wage if the revenue is high. If the agent rejects, both parties get utility zero. If the agent accepts, the agent chooses low or high effort. The principal pays the wage as agreed in the contract. Suppose, hypothetically, the agent always chose the effort level proposed by the principal.
