(a) The principal can opt to centralise the decision but before making her decision -given she does not know what the state of the economy is - she asks forrecommendations from her two division managers. Centralisation means that theprincipal commits to implement a decision that is the average of the tworecommendations she received from her managers. The recommendations are sentsimultaneously and cannot be less than 0 or greater than 1.Assume that the state of the economy s = 0.7. What is the report (or recommendation)that Manager A will send if Manager B always truthfully reports s?(b) The principal is going to centralise the decision and will ask for a recommendationfrom both managers, as in the previous question. Now, however, assume that bothmanagers strategically make their recommendations. What are the recommendationsrA and rв made by the Managers A and B, respectively, in a Nash equilibrium?(c) What the principal's expected utility (or loss) under centralised decision making(as in part b)?(d) Canyou design a contract for both of the managers that can help the principalimplement their preferred option? Why might this contract be problematic in the realworld? 3. Consider the following delegation versus centralisation model of decision making,loosely based on some of the discussion in class.A principal has to implement a decision that has to be a number between 0 and 1; thatis, a decision d needs to be implemented where 0≤d≤1. The difficulty for theprincipal is that she does not know what decision is appropriate given the current stateof the economy, but she would like to implement a decision that exactly equals whatis required given the state of the economy. In other words, if the economy is in state s(where 0≤s≤1) the principal would like to implement a decision d = s as theprincipal's utility Up (or loss from the maximum possible profit) is given byUp = -|s-d. With such a utility function, maximising utility really means makingthe loss as small as possible. For simplicity, the two possible levels of s are 0.4 and0.7, and each occurs with probability 0.5.There are two division managers A and B who each have their own biases. ManagerA always wants a decision of 0.4 to be implemented and incurs a disutility UA that isincreasing the further from 0.4 the decision d that is actually implement, specifically,U₁ = -0.4-d|. Similarly, Manager B always wants a decision of 0.7 to beimplement, and incurs a disutility UB that is (linearly) increasing in the distancebetween 0.7 and the actually decision that is implemented - that is U₂ = -0.7-d.Each manager is completely informed, so that each of them knows exactly what thestate of the economy s is.B

As per economics, the principal-agent problem signifies the problem that arises between two parties,…

(a) The principal can opt to centralise the decision but before making her decision - given she does not know what the state of the economy is - she asks for recommendations from her two division managers. Centralisation means that the principal commits to implement a decision that is the average of the two recommendations she received from her managers. The recommendations are sent simultaneously and cannot be less than 0 or greater than 1. Assume that the state of the economy s = 0.7. What is the report (or recommendation) that Manager A will send if Manager B always truthfully reports s? (b) The principal is going to centralise the decision and will ask for a recommendation from both managers, as in the previous question. Now, however, assume that both managers strategically make their recommendations. What are the recommendations гA and гB made by the Managers A and B, respectively, in a Nash equilibrium? (c) What is the principal's expected utility (or loss) under centralised decision making (as in part b)? (d) Can you design a contract for both of the managers that can help the principal implement their preferred option? Why might this contract be problematic in the real world?

(a) The principal can opt to centralise the decision but before making her decision - given she does not know what the state of the economy is - she asks for recommendations from her two division managers. Centralisation means that the principal commits to implement a decision that is the average of the two recommendations she received from her managers. The recommendations are sent simultaneously and cannot be less than 0 or greater than 1. Assume that the state of the economy s = 0.7. What is the report (or recommendation) that Manager A will send if Manager B always truthfully reports s? (b) The principal is going to centralise the decision and will ask for a recommendation from both managers, as in the previous question. Now, however, assume that both managers strategically make their recommendations. What are the recommendations гA and гB made by the Managers A and B, respectively, in a Nash equilibrium? (c) What is the principal's expected utility (or loss) under centralised decision making (as in part b)? (d) Can you design a contract for both of the managers that can help the principal implement their preferred option? Why might this contract be problematic in the real world?

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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