Contract theory
Contract Theory
Contract theory (pronunciation: /ˈkɒntrækt ˈθɪəri/) is a term used in Economics and Law to describe the study of how economic actors can and do construct contractual arrangements. Contract theory draws upon principles of financial economics, and complex systems.
Etymology
The term "contract theory" is derived from the English words "contract" and "theory". The word "contract" comes from the Latin contractus, past participle of contrahere meaning "to draw together", while "theory" is derived from the Greek word theoria, meaning "contemplation, speculation".
Definition
Contract theory involves the study of contracts. Contracts are defined as agreements that are enforceable by law. The theory focuses on the conditions under which contracts are formed, how they are structured, and how external factors can influence contract behavior.
Related Terms
- Principal-agent problem: This is a problem in contract theory where one party (the agent) is allowed to make decisions on behalf of another party (the principal).
- Moral hazard: This refers to the risk that one party has not entered into the contract in good faith or has provided misleading information about its assets, liabilities, or credit capacity.
- Adverse selection: This is a concept in economics describing situations where an individual's demand for insurance (either the propensity to buy insurance, or the quantity purchased, or both) is positively correlated with the individual's risk of loss.
- Incomplete contracts: These are contracts that do not specify the legal actions that are to be taken in every possible set of circumstances.
- Information asymmetry: This is the study of decisions in transactions where one party has more or better information than the other.
External links
- Medical encyclopedia article on Contract theory
- Wikipedia's article - Contract theory
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