Explain the concept of principal-agent problem.

The principal-agent problem refers to a situation in which an individual or entity (the principal) delegates decision-making authority to another individual or entity (the agent) to act on their behalf. However, there is a conflict of interest between the principal and the agent, as the agent may not always act in the best interest of the principal.

This problem arises due to information asymmetry, where the agent possesses more information about their own actions and intentions than the principal. The agent may have incentives to act in a way that benefits themselves rather than the principal, leading to a divergence between the goals of the principal and the actions of the agent.

The principal-agent problem is prevalent in various economic settings, such as corporate governance, government agencies, and even in everyday situations like hiring contractors or employees. It can result in inefficiencies, moral hazards, and adverse selection, as the principal may not have full control or knowledge of the agent's actions.

To mitigate the principal-agent problem, mechanisms such as contracts, monitoring, performance-based incentives, and aligning the interests of the principal and agent are often employed. These measures aim to reduce the information asymmetry and ensure that the agent acts in the best interest of the principal.