7. Principal-Agent IIA risk-neutral principal can hire a risk-averse agent to undertake a project. Thereare two possible outcomes for the gross profit of the principal, TLThere are also two possible effort levels that the agent can exert, e = 0 or 1; if e = 0,the probability of TH is only 1/3, but if e = 1, the probability of TH increases to 2/3.20 and TH = 50.The agent's utility from receiving a wage wand exerting effort e is Vw – e, and theagent has a reservation utility of ū = 2.(a) Assume that effort is observable.What wage will the principal offer if she wants to induce low effort?What wage will she offer if she wants to induce high effort?What contract is optimal for the principal?

Entities or individuals acting as risk-neutral principals focus on maximizing potential financial…

7. Principal-Agent II A risk-neutral principal can hire a risk-averse agent to undertake a project. There are two possible outcomes for the gross profit of the principal, L = 20 and TH = 50. There are also two possible effort levels that the agent can exert, e = 0 or 1; if e = 0, the probability of H is only 1/3, but if e = 1, the probability of H increases to 2/3. The agent's utility from receiving a wage wand exerting effort e is √√we, and the agent has a reservation utility of ū = 2. (a) Assume that effort is observable. What wage will the principal offer if she wants to induce low effort? What wage will she offer if she wants to induce high effort? What contract is optimal for the principal?

7. Principal-Agent II A risk-neutral principal can hire a risk-averse agent to undertake a project. There are two possible outcomes for the gross profit of the principal, L = 20 and TH = 50. There are also two possible effort levels that the agent can exert, e = 0 or 1; if e = 0, the probability of H is only 1/3, but if e = 1, the probability of H increases to 2/3. The agent's utility from receiving a wage wand exerting effort e is √√we, and the agent has a reservation utility of ū = 2. (a) Assume that effort is observable. What wage will the principal offer if she wants to induce low effort? What wage will she offer if she wants to induce high effort? What contract is optimal for the principal?

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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