Which of the following are ways of coping with the principal-agent problem Using only short term contract Providing incentive pay Giving orders Work leas
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A worker can exert two effort levels, good or bad, which induce a production error with probabilities 0.25 and 0.75 respectively. His utility function is U(w, e) = 100 - (10 * e) - c, where w is the wage received and c takes the value of 2 if effort e is good and 0 if effort is bad. Production errors are observable and can be introduced into the worker's contract, but effort cannot. The production obtained is worth 20 if there are no errors and 0 otherwise. The principal is risk-neutral with a utility function Up(x, w) = x - w. Assume the worker has a reservation utility equal to 0. a. Let the wage offered be ws if the production is successful, and wf if the production fails. a. What is the optimal contract (ws, wf) if the principal wants to induce a good effort level from the worker? b. Should the principal try to induce a high effort level from the worker?
Breanna O.
Question 3: A manufacturing company is looking to hire an agent to manage a new project. The agent can exert a high effort (𝑒𝑒𝐻𝐻)or low effort (𝑒𝑒𝐿𝐿). The high effort increases the probability of project success, but it is more costly for the agent. The company wants to design a contract that ensures the agent will choose to exert high effort and will also be willing to accept the job. If the agent exerts high effort (𝑒𝑒𝐻𝐻), the probability of success is 0.8. If the agent exerts low effort ( 𝑒𝑒𝐿𝐿), the probability of success is 0.4. The agent's cost of exerting high effort is 𝐶𝐶𝐻𝐻= 10, and the cost of exerting low effort is 𝐶𝐶𝐿𝐿 =2. The company's payoff is 100 if the project is successful and 0 if it is not. The agent's utility is given by: 𝑈𝑈 = 𝑊𝑊−𝐶𝐶, i.e. their wage 𝑊𝑊 minus their effort cost. The agent has an outside option with a utility of 5. (a) Design a contract (𝑊𝑊𝑆𝑆, 𝑊𝑊𝐹𝐹) where 𝑊𝑊𝑆𝑆 is the wage if the project is successful and 𝑊𝑊𝐹𝐹 is the wage if the project fails. Write down the incentive compatibility and participation condition that ensures the agent will accept the contract and choose to exert high effort. (8 Marks) (b) Solve the conditions from (a) and find the optimal contract with two sets of payments such that the agent will accept the contract and choose to exert high effort. (8 Marks) (c) What is the company’s expected profits under such contract? (2 Marks)
Briefly explain the principal-agent problem in organisations. With the aid of relevant economic theory and framework, identify and justify the appropriate incentive contracts and incentive tools for the following occupations that can motivate the individual to exert optimal efforts: (a) platform food delivery rider, (b) a branch manager of a local bank, (c) a secondary school teacher, and (d) a researcher in a research & development (R&D) department. (Note: You can also include the followings in your answer: highlighting any potential challenges (weaknesses) of the prescribed incentive contract/tools); identifying and explaining why other incentive contract/tools) are not suitable).
Shu N.
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