Consider the case in which Ineffi can observe Dr Knowsbetter's effort. Write down the participation constraints for the firm and the worker, conditional on high and low effort, respectively. What level of effort maximizes total surplus? (Hint: In your calculations, express the cost of low effort as ej. Replace e = 5, 000 only at the end.)
Consider the case in which Ineffi can observe Dr Knowsbetter's effort. Write down the participation constraints for the firm and the worker, conditional on high and low effort, respectively. What level of effort maximizes total surplus? (Hint: In your calculations, express the cost of low effort as ej. Replace e = 5, 000 only at the end.)
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:Consider the case in which Ineffi can observe Dr Knowsbetter's effort. Write
down the participation constraints for the firm and the worker, conditional
on high and low effort, respectively. What level of effort maximizes total
surplus? (Hint: In your calculations, express the cost of low effort as eį.
Replace e = 5, 000 only at the end.)

Transcribed Image Text:Optimal compensation. Ineffi Inc. is considering hiring Dr Jameela Knows-
better to streamline its operations in Northern Montana. If successful, the project
will yield a payoff of $100,000. If unsuccessful, it will bring a loss of $20,000.
The outcome of the project crucially depends on Dr Knowsbetter's effort, which
can take only two values: High or low. When effort is high, the project is suc-
cessful with probability ph
with probability pi
at $15, 000. Exerting low effort costs her $10,000 less than that. In case it does
not hire Dr Knowsbetter, Ineffi will have to turn to the next best candidate for
the task, that is estimated to bring a net value of $20,000 to the company. If Dr
Knowsbetter does not get this gig, she will go on a vacation in a Maldives' resort
with her girlfriends. She values the vacation at $20, 000. Assume throughout that
wage compensation must be non-negative.
0.9. When effort is low, the project is successful
= 0.7. Dr Knowsbetter values the cost of exerting high effort
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