Paul hires Amy to manage his bakery shop. The following table gives the shop's profits (without subtracting payments to Amy) under 3 different levels of Amy's effort and two different states of the world (good and bad weather). There is an 80% probability that the weather would turn good. Bad weather (20%) Good weather (80%) Low Effort 200 400 Medium Effort 400 800 High Effort 800 1000 The cost of low effort is $10, medium effort $20 and high effort $40. Paul offers a fixed salary of $100 and bonus B if revenue is equal to or higher than $800 and nothing otherwise. What should be the minimum value of B so that Amy would put high effort?

Paul hires Amy to manage his bakery shop. The following table gives the shop's profits (without subtracting payments to Amy) under 3 different levels of Amy's effort and two different states of the world (good and bad weather). There is an 80% probability that the weather would turn good. Bad weather (20%) Good weather (80%) Low Effort 200 400 Medium Effort 400 800 High Effort 800 1000 The cost of low effort is $10, medium effort $20 and high effort $40. Paul offers a fixed salary of $100 and bonus B if revenue is equal to or higher than $800 and nothing otherwise. What should be the minimum value of B so that Amy would put high effort?

Managerial Economics: A Problem Solving Approach

5th Edition

ISBN:9781337106665

Author:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor

Publisher:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor

Chapter17: Making Decisions With Uncertainty

Section: Chapter Questions

Problem 17.2IP

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Question

Paul hires Amy to manage his bakery shop. The following table gives the shop's profits (without
subtracting payments to Amy) under 3 different levels of Amy's effort and two different states of the
world (good and bad weather). There is an 80% probability that the weather would turn good.
Bad weather (20%)
Good weather (80%)
Low Effort
200
400
Medium Effort
400
800
High Effort
800
1000
The cost of low effort is $10, medium effort $20 and high effort $40. Paul offers a fixed salary of
$100 and bonus B if revenue is equal to or higher than $800 and nothing otherwise. What should
be the minimum value of B so that Amy would put high effort?

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