Answered: medium level of effort (at a cost to…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

Fred wants to hire Barney to manage his retail store. Barney can apply a high level of effort (at a cost to him of $30), a medium level of effort (at a cost to him of $10), or a low level of effort (at a cost to him of $0). Fred's profits depend not only of the level of Barney's effort but also on the state of consumer demand. Fred believes that demand will be high with probability 50 percent (and therefore demand will be low with probability 50 percent). Fred has determined the following possible profit levels (before paying Barney) will occur depending on Barney's effort and the state of consumer demand:

		Demand
		low	high
effort	low	20	40
medium	40	80
high	80	100

Of the choices below, what is the largest percentage range of profit provided to Barney that would ensure Barney would supply high effort?

a. any percent greater than 75.00 percent (3/4).

b. any percent greater than 66.66 percent (2/3).

c. any percent greater than 50.00 percent (1/2).
d. any percent greater than 83.33 percent (5/6).

2).

Consider again the previous question regarding retail store management. Suppose that Fred is currently paying Barney a flat $10 wage. Now suppose Bart proposes that Fred offer Barney 83.33 percent of profits (but no wage) as Barney’s compensation contract to elicit a higher effort level. Comparing these two options, we would conclude that:

a. Barney would work at medium effort and Fred would offer such a contract.

b. Barney would work at high effort and Fred would offer such a contract.

c. Barney would not accept the contact.
d. Barney would work at high effort but Fred would not offer such a contract.

3).

Consider again the previous question regarding retail store management. Suppose that Fred is currently paying Barney a flat $10 wage. Now suppose Bart proposes that Fred offer Barney 75 percent of profits (but no wage) as Barney’s compensation contract to elicit a higher effort level. Comparing these two options, we would conclude that:

a. Barney would work at high effort and Fred would offer such a contract.

b. Barney would not accept the contact.

c. Barney would work at medium effort and Fred would offer such a contract.

d. Barney would work at high effort but Fred would not offer such a contract.

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a. Barney would work at medium effort and Fred would offer such a contract.

b. Barney would work at high effort and Fred would offer such a contract.

c. Barney would not accept the contact.
d. Barney would work at high effort but Fred would not offer such a contract.

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