An Introduction to the Economics of Information

Macho-Stadler and Perez-Castrillo wrote a graduate textbook on the economics of information, covering the standard models of contracting under asymmetric information.

The organisation follows the field's three central problems. Moral hazard arises when one party takes an action the other cannot observe, so the contract must be written on observable outcomes that imperfectly reflect the action. The authors develop the principal-agent model, derive the optimal contract under risk aversion, and show the trade-off between insurance and incentives: a risk-averse agent should be insured against outcomes they cannot control, but insurance removes the incentive to act, so the optimal contract exposes the agent to some risk purely to motivate effort.

Adverse selection arises when one party knows something relevant before contracting. The authors develop the screening model in which the uninformed party offers a menu of contracts designed so that each type of counterparty selects the one intended for it, and derive the standard results: the most efficient type receives an information rent, and the contracts offered to less efficient types are distorted away from efficiency to make the sorting work.

Signalling covers the case where the informed party moves first, taking a costly action that credibly conveys their type because it would be more costly for a different type to imitate.

They also cover mechanism design and the revelation principle, moral hazard with multiple agents including tournaments and team production, and repeated relationships.

The book is a technical textbook requiring microeconomics and mathematics. It teaches the models rather than their applications, so readers wanting to see the theory applied to contracting or organisational design must make the translation themselves. The models underpin most modern thinking about incentives, insurance, corporate governance and market design.