The intuition is that if the principal could perfectly monitor whether the agent was working or shirking, they can just specify a cause in the contract the punishes them whenever they shirk. Equivalently, if the principal knows the agent’s cost of production (or ability level), they can extract all the surplus value without leaving any rent.
Pages 40-53 of The Theory of Incentives contrasts these “first best” and “second-best” solutions (it’s easy to find online).
(This rambly comment is offered in the spirit of Socratic grilling.)
I hadn’t noticed I should be confused about the agency rent vs monopoly rent distinction till I saw Wei Dai’s comment, but now I realise I’m confused. And the replies don’t seem to clear it up for me. Tom wrote:
Re the difference between Monopoly rents and agency rents: monopoly rents would be eliminated by competition between firms whereas agency rents would be eliminated by competition between workers. So they’re different in that sense.
That’s definitely one way in which they’re different. Is that the only way? Are they basically the same concept, and it’s just that you use one label (agency rents) when focusing on rents the worker can extract due to lack of competition between workers, and the other (monopoly rents) when focusing on rents the firms can extract due to lack of competition between firms? But everything is the same on an abstract/structural level?
Could we go a little further, and in fact describe the firm as an agent, with consumers as its principal? The agent (the firm) can extract agency rents to the extent that (a) its activities at least somewhat align with those of the principal (e.g., it produces a product that the public prefers to nothing, and that they’re willing to pay something for), and (b) there’s limited competition (e.g., due to a patent). I.e., are both types rents due to one actor (a) optimising for something other than what the other actors wants, and (b) being able to get away with it?
That seems consistent with (but not stated in) most of the following quote from you:
Re monopoly rents vs agency rents: Monopoly rents refer to the opposite extreme with very little competition, and in the economics literature is used when talking about firms, while agency rents are present whenever competition and monitoring are imperfect. Also, agency rents refer specifically to the costs inherent to delegating to an agent (e.g. an agent making investment decisions optimising for commission over firm profit) vs the rents from monopoly power (e.g. being the only firm able to use a technology due to a patent). But as you say, it’s true that lack of competition is a cause of both of these.
What my proposed framing seems to not account for is that discussion of agency rents involves mention of imperfect monitoring as well as imperfect competition. But I think I share Wi Dai’s confusion there. If the principal had no other choice (i.e., there’s no competition), then even with perfect monitoring, wouldn’t there still be agency rents, as long as the agent is optimising for something at least somewhat correlated with the principal’s interests? Is it just that imperfect monitoring increases how much the agent can “get away with”, at any given level of correlation between its activities and the principal’s interests?
And could we say a similar thing for monopoly rents—e.g., a monopolistic firm, or one with little competition, may be able to extract somewhat more rents if it’s especially hard to tell how valuable its product is in advance?
Note that I don’t have a wealth of econ knowledge and didn’t take the option of doing a bunch of googling to try to figure this out for myself. No one is obliged to placate my lethargy with a response :)
The intuition is that if the principal could perfectly monitor whether the agent was working or shirking, they can just specify a cause in the contract the punishes them whenever they shirk. Equivalently, if the principal knows the agent’s cost of production (or ability level), they can extract all the surplus value without leaving any rent.
Pages 40-53 of The Theory of Incentives contrasts these “first best” and “second-best” solutions (it’s easy to find online).
(This rambly comment is offered in the spirit of Socratic grilling.)
I hadn’t noticed I should be confused about the agency rent vs monopoly rent distinction till I saw Wei Dai’s comment, but now I realise I’m confused. And the replies don’t seem to clear it up for me. Tom wrote:
That’s definitely one way in which they’re different. Is that the only way? Are they basically the same concept, and it’s just that you use one label (agency rents) when focusing on rents the worker can extract due to lack of competition between workers, and the other (monopoly rents) when focusing on rents the firms can extract due to lack of competition between firms? But everything is the same on an abstract/structural level?
Could we go a little further, and in fact describe the firm as an agent, with consumers as its principal? The agent (the firm) can extract agency rents to the extent that (a) its activities at least somewhat align with those of the principal (e.g., it produces a product that the public prefers to nothing, and that they’re willing to pay something for), and (b) there’s limited competition (e.g., due to a patent). I.e., are both types rents due to one actor (a) optimising for something other than what the other actors wants, and (b) being able to get away with it?
That seems consistent with (but not stated in) most of the following quote from you:
What my proposed framing seems to not account for is that discussion of agency rents involves mention of imperfect monitoring as well as imperfect competition. But I think I share Wi Dai’s confusion there. If the principal had no other choice (i.e., there’s no competition), then even with perfect monitoring, wouldn’t there still be agency rents, as long as the agent is optimising for something at least somewhat correlated with the principal’s interests? Is it just that imperfect monitoring increases how much the agent can “get away with”, at any given level of correlation between its activities and the principal’s interests?
And could we say a similar thing for monopoly rents—e.g., a monopolistic firm, or one with little competition, may be able to extract somewhat more rents if it’s especially hard to tell how valuable its product is in advance?
Note that I don’t have a wealth of econ knowledge and didn’t take the option of doing a bunch of googling to try to figure this out for myself. No one is obliged to placate my lethargy with a response :)