Microeconomics: Theory and Applications with Calculus, 4e

19.2 Production Efficiency

We start by examining situations with no risk due to random events, so that total profit, $\pi (a),$[&|pi|(a),&] is solely a function of the agent’s action, a. Production efficiency is achieved by maximizing total or joint profit: the sum of the principal’s and the agent’s individual profits.

Efficient Contract

To be efficient and to maximize joint profit, the contract that a principal offers to an agent must have two properties. First, the contract must provide a large enough payoff that the agent is willing to participate in the contract. We know that the principal’s payoff is adequate to ensure the principal’s participation because the principal offers the contract.

Second, the contract must be incentive compatible