Boris and Priti have to work together on a project as agents. Ursula, the principal, will get a payoff of 12 if they complete it successfully but she can only observe the outcome not how much effort Boris and Priti are putting in. Boris and Priti can choose either to work or shirk where working costs 4 and shirking nothing. The project will be successful only if both Boris and Priti work, otherwise it fails. The payoff that Ursula offers for successful project completion is R, which is split equally between Boris and Priti. (a) Why does it matter that Ursula cannot observe the effort put in by Boris and Priti? What outcome do you expect to be reached if Ursuala cannot observe what Boris and Priti do? (b) Write down the payoff matrix to represent how Boris and Priti decide whether to work or shirk and derive the pure strategy Nash equilibria. (c) Compare the outcome when R = 2, 4 or 9. Does this mean that higher rewards do not always elicit more effort? (d) Do you think that it would matter to the outcome whether Boris and Priti coordinate their effort decisions? (e) Do you think that it would be better or worse for Ursula is she could break the project in two sub-projects and have Boris and Priti work separately where effort still costs 4 but success for one of them now yields 5?
Boris and Priti have to work together on a project as agents. Ursula, the principal, will get a payoff of 12 if they complete it successfully but she can only observe the outcome not how much effort Boris and Priti are putting in. Boris and Priti can choose either to work or shirk where working costs 4 and shirking nothing. The project will be successful only if both Boris and Priti work, otherwise it fails. The payoff that Ursula offers for successful project completion is R, which is split equally between Boris and Priti. (a) Why does it matter that Ursula cannot observe the effort put in by Boris and Priti? What outcome do you expect to be reached if Ursuala cannot observe what Boris and Priti do? (b) Write down the payoff matrix to represent how Boris and Priti decide whether to work or shirk and derive the pure strategy Nash equilibria. (c) Compare the outcome when R = 2, 4 or 9. Does this mean that higher rewards do not always elicit more effort? (d) Do you think that it would matter to the outcome whether Boris and Priti coordinate their effort decisions? (e) Do you think that it would be better or worse for Ursula is she could break the project in two sub-projects and have Boris and Priti work separately where effort still costs 4 but success for one of them now yields 5?
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:Boris and Priti have to work together on a project as agents. Ursula, the principal, will get a payoff of
12 if they complete it successfully but she can only observe the outcome not how much effort Boris
and Priti are putting in. Boris and Priti can choose either to work or shirk where working costs 4 and
shirking nothing. The project will be successful only if both Boris and Priti work, otherwise it fails. The
payoff that Ursula offers for successful project completion is R, which is split equally between Boris
and Priti.
(a) Why does it matter that Ursula cannot observe the effort put in by Boris and Priti? What outcome
do you expect to be reached if Ursuala cannot observe what Boris and Priti do?
(b) Write down the payoff matrix to represent how Boris and Priti decide whether to work or shirk
and derive the pure strategy Nash equilibria.
(c) Compare the outcome when R = 2, 4 or 9. Does this mean that higher rewards do not always
elicit more effort?
(d) Do you think that it would matter to the outcome whether Boris and Priti coordinate their effort
decisions?
(e) Do you think that it would be better or worse for Ursula is she could break the project in two
sub-projects and have Boris and Priti work separately where effort still costs 4 but success for
one of them now yields 5?
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