communication from subcontractor Ralph is trying to finish a rush j ob for a favored customer. The schedule is tight and Ralph can save 8,000 in overtime cost if part of the job is tumed over to aloeal subcontractor. The subcontractor's opportunity cost is either 4,000 or 6,000. The subcontractor knows its eost, but Ralph is uninformed. Let a be Ralph' s probabitity the subcontractor's cost is low (i.e., 4,000). Ralph is risk neutraI; time is critical and Ralph must make a take-it-or-Ieave-it offer to the subcontractor.

a] Suppose a = 0, so the subcontraetor is a high-cost type and Ralph knows it;

what should Ralph do?

b] Suppose a = 1, so the subcontractor is a low-cost type and Ralph knows it; what should Ralph do?

e] Determine Ralph's optimal strategy for all possible values of

a. Why does Ralph forego trade with the subcontractor on occasion, even though it is common knowledge such trade would be mutually heneficial?

d] The strategy you detennined in [e] above ean be interpreted as one in whieh Ralph designs a contract in which trade will take plaee at known tenns, depending on what the subcontraetor elaims the cost is; and the subcontraetor is motivated to eandidly reveal that cost. Provide such an interpretation. Why does Ralph commit to "underutilize" the subcontractor's revelation?AppendixLO1