Contract thery uses the Rational Actor Paradigm to determine optimal contracts when information is costly and asymmetric

Nobel Prize in Economics Awarded to Oliver Hart and Bengt Holmström for Work on Contract Theory
by: Charles Duxbury and Mike Bird
Oct 11, 2016
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TOPICS: Contracts

SUMMARY: The 2016 Nobel Prize in Economic Sciences was awarded jointly to Oliver Hart of Harvard and Bengt Holmström of MIT for their contributions to contract theory.

CLASSROOM APPLICATION: The article informs students about this year's Nobel Prize recipients and offers brief statements about the theory of contracts. Instructors can use the article to inspire students to investigate the economics issues involved in contracts.

QUESTIONS: 
1. (Advanced) Why are contracts and a well-functioning legal system to enforce them important to the functioning of an economy? Research question. Distinguish a "complete contract" from an "incomplete contract."

2. (Advanced) What are the incentive issues in the design of contracts for executive compensation?

3. (Introductory) What is an example of a pitfall in the design of a contract for example between a buyer and supplier?

4. (Advanced) What is the incentive problem created by a government bailing out a failed bank?

Reviewed By: James Dearden, Lehigh University