In which of the following circumstances would a principal–agent problem occur?

• A. When firms operate in a perfectly competitive market
• B. When buyers and sellers have perfect information about a product
• C. When a manager (agent) makes decisions that benefit themselves rather than the shareholders (principal)
• D. When the government sets a price ceiling below equilibrium price

Answer: (C)

Verified step by step guidance

1. Understand the principal-agent problem: it arises when one party (the agent) makes decisions on behalf of another party (the principal), but their interests are not perfectly aligned, leading the agent to act in their own interest rather than the principal's.
2. Analyze each option to see if it involves a situation where one party delegates decision-making to another with potentially conflicting incentives.
3. Recognize that in a perfectly competitive market, firms are price takers and the problem described does not inherently involve delegation or conflicting incentives between principal and agent.
4. Note that perfect information between buyers and sellers eliminates information asymmetry but does not necessarily create a principal-agent relationship.
5. Identify that when a manager (agent) makes decisions benefiting themselves rather than shareholders (principal), this is a classic example of the principal-agent problem due to conflicting incentives and information asymmetry.