Information and Economic Efficiency
Richard Arnott, Bruce Greenwald, Joseph E. Stiglitz
NBER Working Paper No. 4533 (Also Reprint No. r1992)
Is an economy with adverse selection, moral hazard, or an incomplete set of risk markets "constrained" Pareto efficient? There are two sets of papers addressing this question, one asserting that, under seemingly quite general conditions, the economy is constrained Pareto efficient, the other (to which we have contributed) that it is not. In this paper, we delineate the differences in assumptions between the two sets of papers, and under our assumptions present an intuitive proof of the Pareto inefficiency of market equilibrium with moral hazard and identify what it is that the government can do that the market cannot.
Published: Information Economics and Policy Vol. 6 (1994), pp. 77-88