Question

Contracting around observable characteristics to try and solve information problems are examples of

A. first best efficient outcomes

B. second best efficient outcomes

C. positive externalities

D. negative externalities

E. creative destruction

Answer 1

Answer

The correct answer of the question is B).
A) is not the correct answer because first best efficient outcome refers to achieving Pareto efficiency where there is perfect competition and the authority cannot make anything better for one
individual without worsening the situation of others. So there is no contraction occurring .
B) is the correct answer because in real life we cannot attain the idealistic situation of Pareto efficiency and we drift away from perfect competition the second best efficient outcome refers to a situation where the agent has already specified the preferences and the labour income are contracted to achieve the profit. So this is the correct answer because in this theory recession of observable characteristics occur to solve the problems .
C) is not the correct answer because in positive externalities causes indirect to individuals benefit them so there is no observable characteristics
D) is not the correct answer because in negative externalities causes indirect cost to the individuals so no directly visible agent is involved.
E) is not the correct answer because creative destruction is a theory that states innovations in the manufacturing industry leads to progress. This is clearly not connected with the above situation

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