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Nobel Economics Winners Oliver Hart and Bengt Holmström

4 Things to Know About the Nobel Economics Winners Oliver Hart and Bengt Holmström

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This year’s Nobel Prize Winners for Economics were Oliver Hart and Bengt Holmstrom, who have developed theoretical tools for contract writing that would ensure that all parties mutually benefit from a contract.  Contracts determine regulations for future actions, sharing risk, and various other conditions. Many times, it is hard for regular citizens, businesses and public organizations to assess which choices are beneficial versus detrimental. Hart and Holmstrom’s theory allows them to think clearly about such matters.

In particular, I’d like to discuss this idea of Incomplete Contracts. Basically, when we write up contracts, we are writing what decisions to make in the event of any one occasion. However, it is impossible to in detail, draw up every possible scenario that may occur, and decide what to do in each circumstance. And in the event that something happens that was not planned for, the contract becomes obsolete. Instead, Hart states that we must generalize a method of making decisions instead.

Hart states that we “must instead specify who has the right to decide what to do when the parties cannot agree. The party with this decision right will have more bargaining power, and will be able to get a better deal once output has materialized.”

This means that we are allocating the decision rights to one party involved in the contract, giving them an immense amount of power, such as we have learned in class. Thus there is no Nash equilibrium or balanced bargaining power. This would make it such that parties with decision rights have stronger incentives than those with less rights to decision making.

This idea can also help when thinking about the privatization of certain government services. Hart in particular found that privatized institutions and services have a strong incentive for cost reduction, but by simultaneously decreasing quality, which may point to problems in privatized prison systems since people in charge have less of an incentive to maintain quality  since they have less payoff.

 

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