7. Principal-Agent II A risk-neutral principal can hire a risk-averse agent to undertake a project. There are two possible outcomes for the gross profit of the principal, L = 20 and TH = 50. There are also two possible effort levels that the agent can exert, e = 0 or 1; if e = 0, the probability of H is only 1/3, but if e = 1, the probability of H increases to 2/3. The agent's utility from receiving a wage wand exerting effort e is √√we, and the agent has a reservation utility of ū = 2. (a) Assume that effort is observable. What wage will the principal offer if she wants to induce low effort? What wage will she offer if she wants to induce high effort? What contract is optimal for the principal?
7. Principal-Agent II A risk-neutral principal can hire a risk-averse agent to undertake a project. There are two possible outcomes for the gross profit of the principal, L = 20 and TH = 50. There are also two possible effort levels that the agent can exert, e = 0 or 1; if e = 0, the probability of H is only 1/3, but if e = 1, the probability of H increases to 2/3. The agent's utility from receiving a wage wand exerting effort e is √√we, and the agent has a reservation utility of ū = 2. (a) Assume that effort is observable. What wage will the principal offer if she wants to induce low effort? What wage will she offer if she wants to induce high effort? What contract is optimal for the principal?
Chapter2: Mathematics For Microeconomics
Section: Chapter Questions
Problem 2.16P
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