Reference no: EM133646674

Discussion Post: Principal Agent

This discussion will focus on asymmetric information, moral hazard, and adverse selection. Sometimes there can be confusion as to these terms' meanings and connections. To prepare for the discussion, watch the following videos:

1) What is the Principal Agent Problem?
2) What is Agency Problem?

Additionally, review the following:

George Akerlof shook much of the economic world and won the Nobel Prize for asking What if everybody who is a party to an economic transaction doesn't have the same information?

You may remember one of the basic assumptions of competitive markets is that buyers and sellers have perfect and identical information. There is a similar assumption for imperfectly competitive markets that information can be obtained at little or no cost. For a huge number of markets, neither of these is even close to true. When information is not the same on both sides of the market-or when it is very hard or costly for the unknowing party to gain parity of information-we are likely to find market failure called "adverse selection" or "moral hazard."

Your instructor may also post additional resources to help further explain concepts related to this week's discussion.

Context

In this discussion, you will examine a well-known principal-agent contract, the sale of your home by a licensed realtor. You will use the following data to analyze this case.

1) Your home is the typical home, approximately 1,875 sq ft with 3 bedrooms and 2.5 baths. You will list the home at the median home price for your area $425,000. You have done some research and most homes in this value range are closing within 26 days of being listed.

2) The typical commission for homes in your value range is 6%. You and your realtor have signed a sales agreement for a 6% commission. The commission is typically split between the agent for the seller and the agent for the buyer, i.e. 3% of the 6% commission will go to your agent.

3) Research shows that realtors in your area, when selling their properties, typically leave the properties listed for 10 days longer than the average listing-to-closing time of 26 days.

4) After 15 days on the market, you receive an offer of $405,000. The agent recommends that you accept the offer.