Dysfunctional Non-Market Institutions and the Market

There is a widespread belief that when significant market failure occurs, there are strong incentives for non-market institutions to develop which go at least part of the way to remedying the deficiency. We demonstrate that this functionalist position is not in general valid. In particular, we examine a situation where insurance is characterized by moral hazard. We show that when market insurance is provided, supplementary mutual assistance between family and friends (unobservable to market insurers) -- a form of non-market institution -- will occur and may be harmful. This example suggests that non-market institutions can arise spontaneously even though they are dysfunctional.

The Basic Analytics of Moral Hazard

This paper develops the basic analytics of moral hazard, for the two-outcome case where either a fixed damage accident occurs or it does not. The analysis focuses on the relationship between the insurance premium paid and the insurance benefits received in the event of an accident, and is conducted in benefit-premium space. The central message of the paper is that even when the underlying functions, the expected utility function and the function relating the accident probability to accident-prevention effort, are extremely well-behaved, the indifference curves and feasibility set (the set of insurance contracts which at least break even) are not-indifference curves need not be convex and feasibility sets never are; price-and income- consumption lines may be discontinuous; and effort is not in general a monotonic or continuous function of the parameters of the insurance policies provided. Part I of this paper establishes these results, while Part II discusses sane of their implications. The bad behavior of indifference curves and the feasibility set profoundly affects the nature and existence of a competitive equilibrium. We illustrate this, though we do not provide a thorough analysis. We also show that our canonical model of an insurance market with moral hazard can be reinterpreted to provide a model of loans with bankruptcy, or of work incentives.

Moral Hazard and Optimal Commodity Taxation

The central result of this paper is that when moral hazard ispresent,competitive equilibrium is almost always (constrained) inefficient. Moral hazard causes shadow prices to deviate from market prices. To remedy this market failure, the government could introduce differential commodity taxation. Moral hazard causes people to take too little care to prevent accidents. The corresponding dead-weight loss can be reduced by subsidizing (taxing) those goods the consumption of which encourages (discourages) accident avoidance.At the (constrained) optimum, the sum of the deadweight losses as-sociated with moral hazard, on the one hand, and differential commodity taxation, on the other, is minimized.

Randomization with Asymmetric Information

It is by now well-known that, in the presence of moral hazard or adverse selection, randomization of insurance premia and benefits may be Pareto efficient. This paper: i) provides a typology of the various forms that randomization may take; ii) derives necessary and/or sufficient conditions for the desirability of these various forms of randomization; iii) obtains some simple characterization theorems of the efficient random policies; iv) gives some intuition behind the results; and v) considers why randomization appears to occur less often in practice than the theory suggests it should.

Information Externalities in Oil and Gas Leasing

Stiglitz and Leitzinger address information externalities in oil and gas leasing

Stockholder Unanimity in Making Production and Financial Decisions

We show that "spanning" does not imply stockholder unanimity if there is trading in the shares of firms. Each basis vector of the space spanned by all firms' output vectors can be treated like a composite commodity. If, in addition to spanning, firms act as price takers with respect to prices of composite commodities, then there is unanimity. We analyze the spanning assumption for the vector space of contingent claims generated by firms' choices of debt-equity ratios. We show that there is a strong relationship between the Modigliani-Miller theorem, spanning, and the existence of a complete set of markets

Some Lessons from the New Public Finance

Stiglitz and Boskin provide us with lessons from the new public finance

Toward a Reconstruction of Keynesian Economics: Expectations and Constrained Equilibria

A two-period model of temporary equilibrium with rationing is presented, paying particular attention to agents' expectations of future constraints. It is shown that with arbitrary constraint expectations many different types of current equilibrium may be consistent with the same set of (current and expected future) wages and prices, and that constraint expectations exhibit "bootstraps" properties (e.g., a higher expectation of Keynesian unemployment tomorrow increases the probability that it will prevail today). In addition, the concept of rational constraint expectations (i.e., perfect foresight of future constraints) is introduced and shown to enhance rather than reduce the effectiveness of government policy

Moral Hazard and Optimal Commodity Taxation

This paper demonstrates that in an economy with moral hazard and more than one commodity, competitive equilibrium is not constrained-efficient. To correct the market failure, differential commodity taxation is necessary. A general optimal tax formula is derived, and special cases are discussed

Aggregate Land Rents and Aggregate Transport Costs

This paper explores the relationship between aggregate land rents and aggregate transport costs for land markets in which locations differ solely in terms of accessibility