0 views

Uploaded by Hitesh Rangra

EC537 Slides Lecture

- Attachment 8faa9f8456685a8a9dcfc4f38bcd2d7f
- FIDIC & Recent Infrastructure Developments - BOT
- Activity for Legal Research (1)
- Similarities of Standard Forms of Contract in Malaysia
- 111
- Provisional Sum
- defective contracts
- 16_4_6
- Untitled
- Maintenance Contract
- Project Closure
- Untitled
- Chan vs Maceda
- Third Division
- Ch03 Internalizing Externalities_2015
- Soca
- Y-India
- ITMV2
- Untitled
- Jordan v. Hall-Miller Drilling Co, 203 F.2d 443, 10th Cir. (1953)

You are on page 1of 79

Leonardo Felli

CLM.G.4

8 November 2011

Course Outline

Information, Bilateral trading.

Intertemporal Incentives.

Unverifiable Information.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part II:

8 November

Lecture 1 2011 2 / 79

Admin

Office Hours:

Wednesday 3:30-4:30 p.m.

or by appointment (e-mail lfelli@econ.lse.ac.uk).

http://econ.lse.ac.uk/staff/lfelli/teaching

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part II:

8 November

Lecture 1 2011 3 / 79

References: Contract Theory

University Press, 1995.

Inncentives: The Principal-Agent Model, Princeton and Oxford:

Princeton University Press, 2002.

Cambridge: M.I.T. Press, 2004.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part II:

8 November

Lecture 1 2011 4 / 79

The Contract

What is a contract?

Definition

A contract is the ruling of an economic transaction: the description of the

performance that the contracting parties agree to complete at a (possibly

future) date.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part II:

8 November

Lecture 1 2011 5 / 79

Example: a contract for the purchase of a specific item, say a meal. It

specifies:

cooking details, etc. . . ),

Contracts involve not only the contracting parties, but also outsiders

(enforcing authority: Court or Enforcer).

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part II:

8 November

Lecture 1 2011 6 / 79

We distinguish between implicit and explicit contracts.

which the contracting parties operate corresponds to the extensive

form of a game whose (unique) subgame perfect Nash equilibrium

(PBE) exactly corresponds to the outcome the parties would like to

implement.

communication. The two rational individuals will behave in the way

required.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part II:

8 November

Lecture 1 2011 7 / 79

If the outcome the parties would like to implement is not the

subgame perfect Nash equilibrium of the environment in which they

operate the parties might want to modify the environment.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part II:

8 November

Lecture 1 2011 8 / 79

The role of the enforcer is to force the parties to behave in a way that

differs from the one that would arise in the absence of any agreement.

corresponding to a new game for the parties.

The usual way for the enforcer to guarantee that the parties operate

in this new environment is by modifying the parties’ payoffs, when

necessary.

play a game that differs from the initial one they were in.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part II:

8 November

Lecture 1 2011 9 / 79

To see how the presence of an enforcer may work consider the

following example: (Kreps, 1984)

Let

v >c

In other words, trade is socially efficient.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 10 / 79

Let p be a reasonable price level (we abstract for the moment from

bargaining) such that:

v > p > c.

B’s and S’s situation may be described by the following normal form:

pay p v − p, p − c −p, p

not pay p v , −c 0, 0

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 11 / 79

The unique Nash equilibrium (dominant solvable) is:

The situation does not change if any of the following two extensive

forms are played.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 12 / 79

The unique SPE of the following game is:

Bb

@

pay p @ not pay p

@

@

S @S

q @q

L L

L L

deliver L not deliver L not

L L

L deliver L deliver

L L

q Lq q Lq

(v − p, p − c) (−p, p) (v , −c) (0, 0)

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 13 / 79

The unique SPE of the following game is:

Sb

@

deliver @

@not deliver

@

B @B

q @q

L L

L L

pay p L not pay p L not

L pay p L pay p

L L

L L

q Lq q Lq

(p − c, v − p) (−c, v ) (p, −p) (0, 0)

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 14 / 79

Solution: to this inefficiency is an explicit contract enforced by a third

party (enforcer).

It specifies:

the item,

enforcer on B in the event that S delivers and B does not pay,

enforcer on S in the event that B pays but S does not deliver.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 15 / 79

In this case the normal form describing the contracting parties

problem once the contract is in place is:

pay p v − p, p − c FS − p, p − FS

not pay p v − FB , FB − c 0, 0

(B pays p, S delivers).

(renegotiation proof). The latter property does not always hold.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 16 / 79

Consider now an environment in which when a party goes to the

enforcer (goes to court) detection is costly (κ) and is successful only

with probability π.

π FS − (1 − π)κ − p, p − π (FS + κ)

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 17 / 79

Notice that as deterrence goes: the detection probability (policing,

monitoring) π and the size of the punishment, FB and FS , are

substitutes (Becker 1968).

The game, below, assumes that the enforcer’s costs κ are paid by the

loosing party (British system):

π FS − (1 − π)κ − p,

pay p v − p, p − c

p − π (FS + κ)

v − π (FB + κ),

not pay p 0, 0

π FB − (1 − π)κ − c

If court’s costs κ are too high the game has multiple Nash equilibria:

(pay p, deliver) and (not pay p, not deliver).

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 18 / 79

This example clearly shows the need for an enforcement mechanism.

relationship/implicit contracting, (multiplicity might be a problem).

(explicit contracting).

a commitment device available to the parties that can be used when

the parties agree to call it in.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 19 / 79

An alternative interpretation is that the enforcer itself is one of the

players of the game.

space and should be explicitly considered in the analysis of the

contractual situation (we will come back to this).

obtain a rather extreme interpretation of a contract (a law) (Mailath,

Morris and Postlewaite 2000).

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 20 / 79

The view is that enforcement/punishment is the only relevant activity.

the parties to coordinate on a particular equilibrium of the game.

contract or by the parliament passing a law.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 21 / 79

From now on we will assume that the two (or more) parties involved

in the contractual relationship operate in a market economy with a

well functioning legal system.

court.

sufficiently severe that no contracting party will ever consider the

possibility of not honoring the contract.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 22 / 79

Coase Theorem:

next natural question is:

can costlessly negotiate a contractual agreement?

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 23 / 79

Theorem (Coase Theorem: Coase (1960))

In an economy where ownership rights are well defined and transacting is

costless gains from trade will be exploited (a contract will be agreed upon)

and efficiency achieved whatever the distribution of entitlements.

That is rational agents write contracts that are individually rational and

Pareto efficient.

by deciding to sign the contract rather then choosing not to sign it.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 24 / 79

This is the reflection of an other basic principle of a well functioning

legal system known as: freedom of contract.

parties always contains the option not to sign the contract.

contract that makes at least one of the contracting party strictly

better off without making any other contracting party worse off.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 25 / 79

Consider the following simple model of a production externality.

input eA at a linear cost c eA (c > 0).

ΠA (eA ) = RA (eA ) − c eA

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 26 / 79

Party B generates revenue RB (eB ) (strictly concave) by choosing the

input eB at the linear cost c eB (c > 0).

B.

ΠB (eB ) − γ eA = RB (eB ) − c eB − γ eA

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 27 / 79

Assume first that the parties choose the amounts of input eA and eB

simultaneously and independently without any prior agreement.

max ΠA (eA )

eA

max ΠB (eB ) − γ eA

eB

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 28 / 79

Consider now the social efficient amounts of input eA∗ and eB∗ .

eA ,eB

RA0 (eA∗ ) = c + γ

RB0 (eB∗ ) = c

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 29 / 79

Comparing (êA , êB ) and (eA∗ , eB∗ ) we obtain using concavity of RA (·):

In other words:

externality.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 30 / 79

Assume now that the two contracting parties have the opportunity to

get together and agree on a contract before the amounts of input are

chosen.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 31 / 79

The former effect is more than compensated by the latter one. This

may create room for negotiation.

Normalize for simplicity the total size of the surplus that is available

to share between the two contracting parties to have size 1 (simple

normalization).

specified.

to the contract.

In other words they define the payoff each party is entitled to without

need for the other party to agree.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 32 / 79

Denote wA and wB the entitlements of party A, respectively B where:

wA + wB < 1.

between the two parties:

and outside options.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 33 / 79

Denote:

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 34 / 79

Extensive Form:

Odd periods:

terminates;

and the game terminates;

option, then the game moves to Stage I of the following

period.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 35 / 79

Even periods:

terminates;

and the game terminates;

option, then the game moves to Stage I of the following

period.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 36 / 79

Payoffs:

If they do not agree and either party takes his outside option in period

n + 1:

πA (σA , σB ) = δ n wA , πB (σA , σB ) = δ n wB .

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 37 / 79

Theorem (Deal Me Out)

For any discount factor δ < 1, and any pair (wA , wB ), wA + wB < 1, the

bargaining game has a unique subgame perfect equilibrium.

Agreement between the parties is immediate and the outside options are

never exercised.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 38 / 79

Proof: (sketch)

Denote xiH , respectively xiL , i ∈ {A, B}, the highest, respectively the

lowest, possible share that A can receive in a subgame that starts

with i making the offer.

xBH ≤ max{wA , δ xAH }, 1 − xAL ≤ max{wB , δ 1 − xBL }

Moreover:

xBL ≥ max{wA , δ xAL }, 1 − xAH ≤ max{wB , δ 1 − xBH }

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 39 / 79

Solving these inequalities we obtain:

If

δ δ

wA ≤ , wB ≤

1+δ 1+δ

then

1 δ

xA = , xB =

1+δ 1+δ

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 40 / 79

If

δ

wA ≥ , wB ≤ δ(1 − wA )

1+δ

then

xA = 1 − δ(1 − wA ), xB = wA

If

δ

wA ≤ δ(1 − wB ), wB ≥

1+δ

then

xA = 1 − wB , xB = δ(1 − wB )

If

wA ≥ δ(1 − wB ), wB ≥ δ(1 − wA )

then

xA = 1 − wB , xB = wA

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 41 / 79

These offers characterize a pair of strategies (σA , σB ).

perfect equilibrium of the bargaining game.

size of the entitlements.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 42 / 79

In particular if each party is entitle to the choice of his input, then:

ΠA (êA )

wA =

ΠA (eA∗ ) + ΠB (eB∗ ) − γ eA∗

ΠB (êB ) − γ êA

wB =

ΠA (eA∗ ) + ΠB (eB∗ ) − γ eA∗

technology, then:

ΠB (êB )

wA = 0, wB =

ΠA (eA∗ ) + ΠB (eB∗ ) − γ eA∗

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 43 / 79

In either case the result above implies that we would get the efficient

outcome: (eA∗ , eB∗ ).

entitlements wA and wB .

and A’s choice of input eA∗ .

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 44 / 79

From now on we are going to focus on models in which the Coase

Theorem fails.

The classic cause for the failure of the Coase Theorem is the presence

of asymmetric information between the parties.

own preferences (hidden information model).

the preferences of one opponent) can always be recast as a game of

imperfect information (a player does not know the history of the

game) (Harsanyi 1967).

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 45 / 79

Asymmetric Information:

under bilateral asymmetric information (a specific extensive form)

with no externalities.

Recall that the Coase Theorem implies efficiency even in the presence

of externalities therefore if inefficiency arises in the absence of

externalities we can conclude that the Theorem fails.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 46 / 79

Notice however that this does not imply that we cannot find an

extensive form that will achieve efficiency.

help in this case: Revelation Principle.

efficiency cannot be achieved whatever extensive form governs the

bargaining between the two parties under bilateral asymmetric

information.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 47 / 79

Consider the following simple model of bilateral trade (double

auction) (Chatterjee and Samuelson, 1983).

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 48 / 79

The action spaces:

The buyer attaches value vb to the unit of the good and is willing to

pay up to vb for it.

The valuations for the unit of the good of the seller and the buyer are

their private information of each player.

takes values in the unit interval.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 49 / 79

The type spaces:

Ts = {0 ≤ vs ≤ 1}, Tb = {0 ≤ vb ≤ 1}

uniformly distributed on [0, 1]:

µs = 1, µb = 1.

If pb ≥ ps then they trade at the average price:

(ps + pb )

p= .

2

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 50 / 79

The payoffs to both the seller and the buyer are then:

(ps + pb )

if pb ≥ ps

us (ps , pb ; vs , vb ) =

v 2 if pb < ps

s

and

(ps + pb )

vb − if pb ≥ ps

ub (ps , pb ; vs , vb ) = 2

0 if pb < ps

and differentiable strategies.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 51 / 79

Consider now the seller’s best reply.

ps

(ps + pb (vb ))

if pb (vb ) ≥ ps

us = 2

v if pb (vb ) < ps

s

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 52 / 79

or

(ps + pb (vb ))

if vb ≥ pb−1 (ps )

us = 2

v

s if vb < pb−1 (ps )

Z pb−1 (ps ) Z 1

(ps + pb (vb )

max vs dvb + dvb

ps vb =0 vb =pb−1 (ps ) 2

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 53 / 79

Recall that by Leibniz’s rule:

!

Z β(y )

∂

G (x, y )dx =

∂y α(y )

Z β(y )

∂G (x, y )

+ dx

α(y ) ∂y

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 54 / 79

Therefore the first order conditions are:

dpb−1 (ps ) 1 dpb−1 (ps )

vs − ps + pb (pb−1 (ps )) +

dps 2 dps

Z 1

1

+ dvb = 0

pb−1 (ps ) 2

dpb−1 (ps ) 1 1

(vs − ps ) + vb p−1 (ps ) = 0

dps 2 b

which gives:

dpb−1 (ps ) 1

1 − pb−1 (ps ) = 0

(vs − ps ) +

dps 2

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 55 / 79

The buyer’s best reply is instead defined by:

pb

(ps (vs ) + pb )

vb − if vs ≤ ps−1 (pb )

ub = 2

0 if vs > ps−1 (pb )

we then get

Z ps−1 (pb )

(ps (vs ) + pb )

max vb − dvs

pb vs =0 2

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 56 / 79

Therefore the first order conditions are:

(ps (ps−1 (pb )) + pb ) dps−1 (pb )

vb − +

2 dpb

Z ps−1 (pb )

1

− dvs = 0

2 vs =0

or

dps−1 (pb ) 1 ps−1 (pb )

[vb − pb ] − vs 0 =0

dpb 2

which gives:

dps−1 (pb ) 1 −1

(vb − pb ) − ps (pb ) = 0

dpb 2

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 57 / 79

To simplify notation we re-write pb−1 (·) = qb (·) and ps−1 (·) = qs (·).

The two differential equations that define the best reply of the seller

and the buyer are then:

1

[qs (ps ) − ps ] qb0 (ps ) − [1 − qb (ps )] = 0

2

1

[qb (pb ) − pb ] qs0 (pb ) − qs (pb ) = 0

2

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 58 / 79

Solving the second equation for qb (pb ) and differentiating yields:

0 1

qb (pb ) = 3−

2 [qs0 (pb )]2

qs (ps )

[qs (ps ) − ps ] 3 − − 1 − ps − 0 =0

[qs0 (ps )]2 qs (ps )

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 59 / 79

This is a second-order differential equation in qs (·) that has a

two-parameter family of solutions.

qs (ps ) = α ps + β

differential equation.

2 1 2 1

ps = vs + , pb = vb +

3 4 3 12

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 60 / 79

This is the (unique) Bayesian Nash equilibrium of this game.

vb ≥ vs

pb ≥ ps

or

2 1 2 1

vb + ≥ vs +

3 12 3 4

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 61 / 79

In other words, in equilibrium trade occurs whenever:

1

vb ≥ vs +

4

vb 6

vs = vb

1 .................................................................

..

..

Trade ..

..

..

..

..

..

.

vb = vs + 4 .... 1

..

..

p 6 .. -

(0, 0) vs

1

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 62 / 79

Revelation Principle:

The obvious question is now: how can we make sure that there does

not exists an alternative way for the parties to achieve efficiency?

Revelation Principle

Harris and Townsend 1981, Dasgupta, Hammond and Maskin 1979)

greatly simplify the set of feasible mechanisms for the parties.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 63 / 79

This Revelation principle says that there is no loss in generality in

restricting attention to direct revelation mechanisms that satisfy

truth-telling constraints.

Recall:

the indirect mechanism is the one in which parties agree to a trade, set

prices etc. . .

the direct mechanism is the one in which parties report their private

information to a mechanism designer who according to the reports

enforces the mechanism.

maximizes the principal’s utility is the way to identify the best

possible indirect mechanism from the principal’s view point.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 64 / 79

Since every BNE of every indirect mechanism has an associated

truth-telling BNE of a direct mechanism if we find the truth-telling

BNE of the direct mechanism that maximizes the principal’s utility

there cannot exist any BNE of the indirect mechanism that is better

for the principal.

Notice that this way to proceed does not require us to specify the

space of all possible indirect mechanisms.

advance: renegotiation may lead to a failure of the revelation

mechanisms (Dewatripont, 1989).

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 65 / 79

Bilateral Trade (Myerson and Satterthwaite 1983)

stage — before they learn their private information — will commit to

a mechanism via the contract.

They will choose their contract in a way that maximizes their ex-ante

welfare.

involve a third party.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 66 / 79

A seller and a buyer trade a single unit of a good.

information:

c ∼ PS (c), c ∈ [c, c]

v ∼ PB (v ), v ∈ [v , v ]

φ is the probability of trade,

t is the transfer from the buyer to the seller.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 67 / 79

By revelation principle restrict attention to truth-telling direct

mechanisms.

Denote:

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 68 / 79

Therefore every truth-telling BNE direct mechanism has to satisfy the

following set of incentive compatibility constraints (IC):

UB (v ) ≥ φ(v̂ ) v − t(v̂ ) ∀v , v̂ ∈ [v , v ]

following individual rationality constraints (IR) to be satisfied:

UB (v ) ≥ 0, ∀v , v̂ ∈ [v , v ]

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 69 / 79

Notice now that both parties’ preferences satisfy the Spence-Mirrlees

single crossing conditions:

∂ ∂UB /∂t

− >0

∂v ∂UB /∂φ

manageable form.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 70 / 79

Theorem (Myerson and Satterthwaite 1983)

For any probability φ(c, v ) there exists a transfer function t(c, v ) that

satisfies (IR) and (IC) if and only if:

where

1 − PB (v ) PS (c)

JB (v ) = v − , JS (c) = c +

pB (v ) pS (c)

and

dφ(c) dφ(v )

≤ 0, ≥0

dc dv

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 71 / 79

Proof:

From the (IC) constraints since for every v̂ > v we must have:

UB0 (v ) = φ(v )

UB (v ) ≥ UB (v )

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 72 / 79

We therefore conclude that the only relevant (IR) constraint is:

UB (v ) ≥ 0

dφ(v )

≥0

dv

Symmetrically for the seller we can prove that (IC) constraint implies:

dφ(c)

≤0

dc

Consider now the differential equation obtained above:

UB0 (v ) = φ(v )

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 73 / 79

Integrating it we obtain:

Z v

UB (v ) = UB (v ) + φ(ν)dν

v

Z c

US (c) = US (c) + φ(γ)dγ

c

0 = Ec [t(c)] − Ev [t(v )] =

Z c Z c

= φ(c) c + φ(γ)dγ pS (c) dc + US (c) +

c c

Z v Z v

+ φ(ν)dν − v φ(v ) pB (v )dv + UB (v )

v v

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 74 / 79

Integrating by parts we get:

US (c) + UB (v ) =

Z c

PS (c)

= − c+ φ(c) pS (c) dc +

c pS (c)

v

1 − PB (v )

Z

+ v− φ(v ) pB (v )dv

v pB (v )

or

US (c) + UB (v ) = Ec,v [φ(c, v ) (JB (v ) − JS (c))]

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 75 / 79

Sufficiency is a bit more complex to prove it requires us to solve the

partial differential equation that is represented by the FOC of the (IC)

constraints.

φi

dφ(c) dφ(v )

≤ 0, ≥0

dc dv

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 76 / 79

Ignoring monotonicity conditions and denoting µ the lagrange

multiplier of the remaining constraint we get a lagrangian function

that is linear in φi :

µ 1 − PB (v ) PS (c)

Ec,v φ(c, v ) (v − c) − −

1−µ pB (v ) pS (c)

strictly positive.

µ 1 − PB (v ) µ PS (c)

v− ≥c+

1−µ pB (v ) 1 − µ pS (c)

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 77 / 79

This φ(c, v ) is weakly monotonic in:

µ 1 − PB (v )

v−

1−µ pB (v )

and

µ PS (c)

c+

1−µ pS (c)

and hence local and global (IC) holds.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 78 / 79

Theorem (Myerson and Satterthwaite 1983)

If c > v and v > c then necessarily µ > 0.

constraint of the parties problem and showing that is violated.

very relevant sense: efficiency is no longer guaranteed by the use of

contracts.

Leonardo Felli (LSE) EC537 Microeconomic Theory for Research Students, Part8II:

November

Lecture 12011 79 / 79

- Attachment 8faa9f8456685a8a9dcfc4f38bcd2d7fUploaded byFabio
- FIDIC & Recent Infrastructure Developments - BOTUploaded byIvan Franc
- Activity for Legal Research (1)Uploaded byJona May Corral Julio
- Similarities of Standard Forms of Contract in MalaysiaUploaded byZinck Hansen
- 111Uploaded byRakesh Kumar
- Provisional SumUploaded byTarek Tarek
- defective contractsUploaded bydenbar15
- 16_4_6Uploaded byelmin_ibrahimov
- UntitledUploaded byeurolex
- Maintenance ContractUploaded byShane Fernandes
- Project ClosureUploaded byannna27
- UntitledUploaded byeurolex
- Chan vs MacedaUploaded byGillian Caye Geniza Briones
- Third DivisionUploaded byBerch Melendez
- Ch03 Internalizing Externalities_2015Uploaded by1234ass
- SocaUploaded byVincent Arnado
- Y-IndiaUploaded bypuneet_26dec
- ITMV2Uploaded byTanya Tandon Kapoor
- UntitledUploaded byeurolex
- Jordan v. Hall-Miller Drilling Co, 203 F.2d 443, 10th Cir. (1953)Uploaded byScribd Government Docs
- Thesis FinalUploaded byIdoot Augustine Obilil
- SM Land v BCDA DigestUploaded byJose Ramon Ampil
- Manila Steamship Co - TyUploaded byLester Balagot
- brokerlist_20120619132852Uploaded byvishesh_mba3
- Essentials of Economics 2Uploaded byIvona Stankovic
- Course Outline _ Legal Aspects of BusinessUploaded byArpita Basu
- X and Y entered into a lease contract cover a house and lot of X.docxUploaded bymaria luz
- Performance_of_contract_BBA.pptxUploaded bySingh Prakash
- Rallos v Go Chan and Sons Realty CoUploaded byReena Ma
- Michael Wetherbee resignation agreementUploaded byThe Livingston County News

- DeaUploaded byHitesh Rangra
- Influx Virus | ရုိဟင္ဂ်ာUploaded bysandrakaung2430
- M.a.M.sc. Part I Mathematics (Ext.reg I) 09Uploaded byHitesh Rangra
- 06_chapter2.pdfUploaded byHitesh Rangra
- vivekananda.docxUploaded byHitesh Rangra
- vivekananda.docxUploaded byHitesh Rangra
- Volume_03Uploaded byඅපේ පොත් එකතුව
- DEMOJUploaded byHitesh Rangra
- M.a.M.sc. Part I Mathematics (Ext.reg I) 09Uploaded bynabakumarj9
- Sankardeva and NVMUploaded byHitesh Rangra
- South Asia Analysis Group - The Muslim Community and Their Leaders_ - 2013-04-04Uploaded byHitesh Rangra
- Khin Mg Saw on RohingyaUploaded byHitesh Rangra
- Kickoff Planning TemplateUploaded byishtiaque_anwar
- Volume_02Uploaded bySuryakantKolekar
- GSEFM 2017 Background Lecture 4Uploaded byHitesh Rangra
- Hart Moore SlidesUploaded byHitesh Rangra
- EC476 Sol Assignment-1Uploaded byHitesh Rangra
- MatUploaded byHitesh Rangra
- Price EstimationUploaded byHitesh Rangra
- EconomicsUploaded byHitesh Rangra
- EconomicsUploaded byHitesh Rangra
- MATH PHD EUI.pdfUploaded byHitesh Rangra
- MATH PHD EUI.pdfUploaded byHitesh Rangra
- Huts Mom TemplateUploaded byHitesh Rangra
- EC537 Reading List PIIUploaded byHitesh Rangra
- Matrix DifferentiationUploaded bytake shobo
- Eliaz Spiegler 2006Uploaded byHitesh Rangra
- EC537 Reading List PI.pdfUploaded byHitesh Rangra
- EC537 Slides Lecture 5Uploaded byHitesh Rangra

- Damanhur the Ecology of SpiritUploaded bylev2468
- gabriellamorziresumesummer2015finalUploaded byapi-280690697
- Credit Refinance FacilityUploaded byAmar Sinha
- sample reportUploaded byapi-239971791
- G.R. No. L-31156Uploaded byly
- The Lighthouse June 10, 2010Uploaded byVCStar
- Maxis Cover Definitions Contents (770KB)Uploaded bylwfang
- 03 social security benefits for children with disabilities en-05-10026Uploaded byapi-309082881
- Presentation1[1]Uploaded byJHECX10268777
- Joan Brown Donna R. Johnson Susan Matarrese Geoffrey Parker Mary Lynn Sheetz Peter Sprunger-Froese v. Colonel James O. Palmer, Base Commander of Peterson Air Force Base, Colorado, and Colonel Eugene T.M. Cullinane, Commander, Headquarters, 3rd Space Support Wing (Afspacecom) Peterson Air Force Base, Colorado, as Officers and Agents of the United States Air Force, an Agency of the United States of America, 915 F.2d 1435, 10th Cir. (1990)Uploaded byScribd Government Docs
- Analysis of Paints Industry in IndiaUploaded bySumit Malhotra
- The Nokia CaseUploaded bysilke331
- 10 Bad Listening HabitsUploaded byapi-3703916
- Auditing Problems 1-1.docxUploaded byJorz Pantaleta
- walsh 633blog oneUploaded byapi-277334388
- Arizona Beverages pre-trial award decisionUploaded byLong Island Business News
- I, Daniel Blake Case StudyUploaded byAnonymous q0XfJW
- Australia Study TourUploaded byDarrell Magsambol
- Flyking BranchlistUploaded byvinaisharma
- BS File StuffUploaded byTrystanOliver
- Presentasi Diskusi TopikUploaded byhafizalfarizie
- The Way Forward for Islamic Finance ResearchUploaded byfaizamf
- RP v CA and CAragUploaded byGil Pino
- Claim Form Etc - Merged PDFUploaded byGaurav Srivastava
- slavery and the making of americaUploaded byapi-315861875
- 3169336Uploaded byMarius Ciulu
- Was Niezsche an Anti-ChristianUploaded byFranco Castorina
- Regional Sales Manager or Food Broker or Distributor Business MaUploaded byapi-121381222
- Strauss - On the Plan of the Guide of the PerplexedUploaded byjeremyphillip
- Genre and Generic StructureUploaded byMonMa