In practice one does not expect conflicting agents to move instantaneously to an equilibrium. Instead the final equilibrium is often the consequence of "disequilibrium dynamics". This paper, through the use of local game theory, introduces a general framework for disequilibrium dynamics based on the existence of adjustment costs. The analysis is presented within the context of oligopoly theory and shows that the existence of adjustment costs will in many cases result in a unique equilibrium at which market shares are inversely proportional to these costs. This paper also introduces two new solution concepts for n-person normal form games.
Doctors often treat similar patients differently, which affects health outcomes and medical spending. We assess the recent literature on doctor decision-making through the lens of a model that incorporates diagnostic and procedural skills, beliefs, incentives, and differences in patient pools. Decision-making is affected by beliefs, training, experience, peer effects, financial incentives, and time constraints. Interventions to improve decision-making include providing information, guidelines, and technologies like electronic medical records and algorithmic decision tools. Economists have made progress in understanding doctor decision-making, but applications of that knowledge to improving health care are still limited.
The purpose of this essay is to review the books Why Nations Fail by Daron Acemoglu and James Robinson, and Pillars of Prosperity by Timothy Besley and Torsten Persson. The essay briefly discusses the main contributions of the books and the role of politics for economic performance. The review then discusses these contributions in the light of recent research on organizational economics, particularly the modern theory of the firm.
When the quality of a good is at the discretion of the seller, how can buyers assure that the seller provides the mutually efficient level of quality? Contracts that provide a bonus to the seller if the quality is acceptable or impose a penalty on the seller if quality is unacceptable can, in theory, provide efficient incentives. But how are such contracts enforced? While the courts can be used, doing so involves high real costs. Informal enforcement, involving a loss of reputation and future access to the market for any party that defaults on a contract, may often be a better alternative. This paper explores the use of both formal and informal enforcement mechanisms, provides a rationale for a variety of observed market mechanisms, and then generates a number of testable hypotheses.
During the last several decades, a growing body of laboratory research has shown that human subjects do not always choose to maximize material payoffs. Economists following the lead of
This paper extends the standard principal–agent model to allow for subjective evaluation. The optimal contract results in more compressed pay relative to the case with verifiable performance measures. Moreover, discrimination against an individual implies lower pay and performance, suggesting that the extent of discrimination as measured after controlling for performance may underestimate the level of true discrimination. Finally, the optimal contract entails the use of bonus pay rather than the threat of dismissal, hence neither “efficiency wages” nor the right to dismiss an employee are necessary ingredients for an optimal incentive contract.
Workers in a long-term relationship often have an incentive to hide their ability early in the relationship to avoid having the firm increase the level of output expected from them in the future. We show that competition for older workers will permit the implementation of efficient piece-rate contracts. When the difficulty of the job is unobserved by the firm, Gibbons (1987) has shown that all piece-rate contracts will be inefficient. Together, these results may explain why piece rates are common in some jobs, such as agricultural work and sales, and not as popular for many manufacturing jobs.
This paper considers the enforceability of employment contracts when employees' performance cannot be verified in court so that piece-rate contracts are not legally enforceable. Part I shows that there exists a variety of self-enforcing implicit contracts, modelled as perfect equilibria in a repeated game, and characterizes all the wage and performance outcomes that can be implemented. Implementation requires a strictly positive surplus from employment, the form of the contract depending on how this surplus is divided between firm and employee. Piece-rate contracts, and contracts with an informally agreed bonus, can be made self-enforcing but the use of severance pay and bonding does not extend the set of implementable allocations. The resulting contracts resemble actual labor contracts more than do the contracts in standard principal-agent models. Part II analyses market equilibrium with these contracts, also modelled as perfect equilibria in a repeated game, and shows that many such equilibria exist. Unfilled vacancies and unemployed workers can co-exist despite the existence of contracts that are potentially mutually beneficial. For those jobs that are filled, any division of the potential surplus is possible so that the market can have, at the same time, involuntary unemployment and vacancies that are unfilled despite filled jobs earning positive profits. As a criterion for selecting equilibria, a notion of renegotiation proofness is applied. Then either all workers are employed or all jobs filled but any division of the potential surplus is still possible. The paper explores what further restrictions on beliefs give rise to a Walrasian outcome, in which all the potential surplus goes to the short side of the market, and to an efficiency wage type outcome, in which the potential surplus goes to the long side.
The employment relationship with employees' ability and their actions both private information (thus combining adverse selection with moral hazard) is modeled as a repeated game with self-enforcing contracts being perfect Bayesian Nash equilibria. Under termination contracts, the equilibrium contract structure consists of a hierarchy of ranks, finite in number even though ability is continuous. Reputation acts as an effective device for worker discipline without the need for involuntary unemployment. Selection by bonding is not, in general, incentive compatible, but selection by promotion of employees through the ranks is. Many other features correspond to observed employment structures.
Expert performance is often evaluated assuming that good experts have good outcomes. We examine expertise in medicine and develop a model that allows for two dimensions of physician performance: decision making and procedural skill. Better procedural skill increases the use of intensive procedures for everyone, while better decision making results in a reallocation of procedures from fewer low-risk to high-risk cases. We show that poor diagnosticians can be identified using administrative data and that improving decision making improves birth outcomes by reducing C-section rates at the bottom of the risk distribution and increasing them at the top of the distribution.