Mixed Models *
The pure models of chapter 2 for adverse selection, chapter 4 for moral hazard and chapter 6 for nonverifiability were highly stylized contracting settings. Each of those models aimed at capturing a single dimension of the incentive problems that may be faced by a principal at the time of designing the contract for his agent. In those chapters, the analysis of each of these respective paradigms has already provided a number of important insights that concern, on the one hand, the conflict (if any) between allocative efficiency and the distribution of the gains from trade and, on the other hand, the form of the optimal compensation schedule. Moreover, our investigation of more complex models than those of chapters 2 and 4 has also shown how the insights gleaned from these simple models carry over in more complex economic environments.1
In real world settings, contracts are rarely designed with the sole objective of solving one incentive problem. Most often, the principal’s control of the agent requires that they deal simultaneously with both adverse selection and moral hazard, or with both the nonverifiability of the state of nature and moral hazard. In
1See chapter 3 for adverse selection and chapter 5 for moral hazard.