Comparison of Socially Optimal vs. Privately Optimal Care
In a principal-agent relationship with hidden actions, the agent's privately optimal level of care is consistently lower than the socially optimal level. This inefficiency arises because the agent's decision-making process only accounts for their private marginal benefit, which is a fraction of the total social marginal benefit. Since the agent does not reap the full rewards of their effort, they choose a level of care where their personal marginal cost equals their personal marginal benefit, falling short of the level where the marginal social benefit equals the marginal cost.
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Socially Optimal Level of Care
Agent's Privately Optimal Level of Care
Comparison of Socially Optimal vs. Privately Optimal Care
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