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MIT 14.129 Contract Theory (Fall 1999)


Susan Athey, E52-252C, x3-6407, Office hours: Wed. 11-12, and by appt.


Bengt Holmstrom , E52-273B, x3-0506


Svetlana Danilkina,, office E52-300


Kelley Donovan (Athey), cubicle in E52-251/252
Deborah Garrity (Holmstrom), cubicle in E52-273/274


Where? When?

  • Lecture: MW10:30-12, E51-361.
  • Recitation: F 10:30-12, E51-361.
  • Exam: TBA.

Lecture Notes


Course Overview

This course is part of the economics department field sequence in microeconomic theory. The course is designed to provide a rigorous treatment of the tools of contract theory, focusing in particular on models with hidden actions and
hidden information. Topics include moral hazard, adverse selection, mechanism design (with a special focus on auction theory), incomplete contracts, and financial contracting.

The course is highly required for students who intend to do theoretical research in microeconomic theory or any of the applied microeconomic fields. The tools developed in the course have become standard for economic modeling in many areas.

Prerequisites and Enrollment

This class is intended primarily for PhD students in the economics department and Sloan school PhD students intending to do formal economic theory in their dissertations. Due to its rigor and intensity, it will probably not serve the needs of master's students or undergraduates very well.

The prerequisite for the course is 14.121, but students with only that background may find the course too difficult. 14.122 and especially 14.124 (which treats many of these topics at an introductory level) are highly recommended.

Course Requirements

There will be approximately six to eight problem sets, which will be graded and will count 20% of the grade. There will also be a final exam. Details will be arranged in class.

Reading List (Please note: updated 10/21/99)

Readings for 2nd half of course:

Below are links to articles that are available on the Web. Some links go directly to the article, other links go to a journal's location in JSTOR (etc.), so just follow links from there to the specific volume and number for the article.

Required Readings:

Segal, I. (1999), "Contracting with Externalities," Quarterly Journal of Economics, 114(2): 337-88.

Milgrom, P. (1988), "Employment Contracts, Influence Activities and Efficient Organization Design," Journal of Political Economy, 96(1):42-60.

Baker, G., R. Gibbons and K. Murphy (1999), "Informal Authority in Organizations," Journal of Law, Economics and Organization, 15 (1).

Grossman, S. and O. Hart (1986), "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, 94(4): 691-719.

Hart, O. and J. Moore (1990), "Property Rights and the Nature of the Firm," Journal of Political Economy, 98 (6): 1119-1158.

Milgrom, P. (1988), "Employment Contracts, Influence Activities and Efficient Organization Design," Journal of Political Economy, 96(1):42-60.

Hart, O. and J. Moore (1988), "Incomplete Contracts and Renegotiation," Econometrica, 56(4): 755-785.

Hermalin, B. and M. Katz (1991), "Moral Hazard and Verifiability," Econometrica, 59(6): 1735-1753.

Suggested Readings:

Laffont, J.-J. and J. Tirole (1988), "The Dynamics of Incentive Contracts," Econometrica, 56(5): 1153-1175.

Bernheim, B. D. and M. Whinston (1986), "Common Agency," Econometrica, 54(4): 923-42.

Legros, P. and S. Matthews (1993), "Efficient and Nearly Efficient Partnerships," Review of Economic Studies, 1993, 60(3): 599-611.

Alchian A and H Demsetz (1972), "Production, Information Costs and Economic Organization," American Economic Review, 62(5): 777-95.

MacLeod, B. and J. Malcomson (1993), "Investment, Hold-Up, and the Form of Market Contracts," American Economic Review, 83(4): 811-37.

Problem Sets and Solutions