Designing efficient contracts are costly when:
A) the monitoring costs are low for the agent.
B) the monitoring costs are low for the principal.
C) there are huge monitoring costs for the principal.
D) there are huge monitoring costs for the agent.

Question

Quizplus · Accepted Answer

When there are huge monitoring costs for the principal, designing an efficient contract becomes costly. This is because the principal needs to spend more resources and effort to monitor the agent's actions to ensure that they are consistent with the terms of the contract. As a result, the principal may face a trade-off between investing in monitoring and designing a contract that aligns the agent's incentives with their goals. Conversely, if the monitoring costs are low for the agent (option A) or the principal (option B), designing an efficient contract may be relatively easier and affordable. Additionally, if monitoring costs are high for the agent (option D), they may have a greater incentive to deviate from the contract, which can lead to higher moral hazard problems.

Designing Efficient Contracts Are Costly When