7. A risk-neutral principal hires an agent to work on a project at wage to. The agent's utility function is U(w,e₁)=√w-g(e) where g(e) is the disutility associated with the effort level e exerted on the project. The agent can choose one of two possible effort levels, e, or ez, with associated disutility levels g(e) = 4, and g(e₂) = 2.5. If the agent chooses effort level ₁, the project yields 100 with probability 1/2, and 0 with probability 1/2. If he chooses e2, the project yields 100 with probability 1/4 and 0 with probability 3/4. The reservation utility of the agent is 0. (a) If effort is observable, which effort level should the principal implement? Derive the best wage contract that implements this effort. Does this involve sharing risk with the agent? Explain your answer. (b) If effort is not observable, which effort level should the principal imple- ment? What is the best wage contract that implements this effort?

7. A risk-neutral principal hires an agent to work on a project at wage to. The agent's utility function is U(w,e₁)=√w-g(e) where g(e) is the disutility associated with the effort level e exerted on the project. The agent can choose one of two possible effort levels, e, or ez, with associated disutility levels g(e) = 4, and g(e₂) = 2.5. If the agent chooses effort level ₁, the project yields 100 with probability 1/2, and 0 with probability 1/2. If he chooses e2, the project yields 100 with probability 1/4 and 0 with probability 3/4. The reservation utility of the agent is 0. (a) If effort is observable, which effort level should the principal implement? Derive the best wage contract that implements this effort. Does this involve sharing risk with the agent? Explain your answer. (b) If effort is not observable, which effort level should the principal imple- ment? What is the best wage contract that implements this effort?

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter7: Uncertainty

Section: Chapter Questions

Problem 7.8P

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