Paula hires Alfred to manage her store. The left column of the table below shows Alfred’s possible effort levels—low and high. Alfred’s personal disutility in terms of dollars depends on his effort level is shown in the second column. The two right columns show the different profits to Priscilla (before paying Alfred’s salary and ignoring his cost of effort) under Low- and High- demand conditions. effort level alfreds cost to effort low demand profit high demand profit low $0 $20 $60 high $10 $60 $100 It is equally likely that demand will be High or Low: chances are 50/50, regardless of how much effort Alfred exerts. They consider two possible contracts: i. Fixed Wage: Alfred receives a fixed wage of $15 ii. Profit Sharing: Alfred receives a share x of the store’s profits but no wage. Assume, to simplify matters, that both Alfred and Paula are risk neutral. Calculate the net expected payoffs for Alfred and Paula under each possible contract offered by Paula and effort level exerted by Alfred. Which of the following alternatives is correct? (a) For Alfred, the fixed wage net payoffs are 15 for any effort level (low or high) (b) For Alfred, the profit-sharing net payoffs are x for any effort level (low or high) (c) For Paula, the fixed wage net payoffs are 50 if low effort and 70 if high (d)For Paula, the profit-sharing net payoffs are 40(1−x)if loweffort and 80(1−x) if high

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Paula hires Alfred to manage her store. The left column of the table below shows Alfred’s possible
effort levels—low and high. Alfred’s personal disutility in terms of dollars depends on his effort
level is shown in the second column. The two right columns show the different profits to Priscilla
(before paying Alfred’s salary and ignoring his cost of effort) under Low- and High- demand
conditions.

effort level	alfreds cost to effort	low demand profit	high demand profit
low	$0	$20	$60
high	$10	$60	$100

It is equally likely that demand will be High or Low: chances are 50/50, regardless of how much
effort Alfred exerts.

They consider two possible contracts:
i. Fixed Wage: Alfred receives a fixed wage of $15
ii. Profit Sharing: Alfred receives a share x of the store’s profits but no wage.

Assume, to simplify matters, that both Alfred and Paula are risk neutral.

Calculate the net expected payoffs for Alfred and Paula under each possible contract offered by
Paula and effort level exerted by Alfred. Which of the following alternatives is correct?
(a) For Alfred, the fixed wage net payoffs are 15 for any effort level (low or high)
(b) For Alfred, the profit-sharing net payoffs are x for any effort level (low or high)
(c) For Paula, the fixed wage net payoffs are 50 if low effort and 70 if high
(d)For Paula, the profit-sharing net payoffs are 40(1−x)if loweffort and 80(1−x) if high

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