Assume, in producing one unit of a good X, an agent can exert either the good effort (G) or the bad effort (L), which cause production defects with probability 0.25 or 0.75 respectively. His utility function in effort e and wage w is U (w, e) = 100 - (10/w) - c(e) where c(G) = 2 for the good effort and c(L) = () for the bad effort. Production defects are contractible and so can be included in the agent's contract, but effort is not contractible. Good X sells for $20 if there are no defects and $0 otherwise. The principal is risk-neutral and likes profit. Assume the agent has a reservation utility/outside option of U=0. Assume for this question that the principal wants to achieve the good effort and that effort is not contractible. Assume the principal offers an optimal 2 part contract {ws, Wf}, where we is paid if there are no defects and Wf is paid if there are any defects. What is the principal's expected profit under the optimal contract in this case? Answer to at most 2 decimal places (rounded), do not include a dollar sign in your answer. Answer:

Assume, in producing one unit of a good X, an agent can exert either the good effort (G) or the bad effort (L), which cause production defects with probability 0.25 or 0.75 respectively. His utility function in effort e and wage w is U (w, e) = 100 - (10/w) - c(e) where c(G) = 2 for the good effort and c(L) = () for the bad effort. Production defects are contractible and so can be included in the agent's contract, but effort is not contractible. Good X sells for $20 if there are no defects and $0 otherwise. The principal is risk-neutral and likes profit. Assume the agent has a reservation utility/outside option of U=0. Assume for this question that the principal wants to achieve the good effort and that effort is not contractible. Assume the principal offers an optimal 2 part contract {ws, Wf}, where we is paid if there are no defects and Wf is paid if there are any defects. What is the principal's expected profit under the optimal contract in this case? Answer to at most 2 decimal places (rounded), do not include a dollar sign in your answer. Answer:

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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