Answered step by step
Verified Expert Solution
Question
1 Approved Answer
1. Paul is planning to hire Alicia for a project. Both are risk neutral with linear utility functions. Paul's utility function is: Uz = R-W,
1. Paul is planning to hire Alicia for a project. Both are risk neutral with linear utility functions. Paul's utility function is: Uz = R-W, where R is revenue and W the wage rate. Alicia's utility function is: U2 = W-e, where e is the level of effort. Alicia may put in a high effort, ex or a low effort, e_. Paul's revenue can be high RH = 20 or low RL = 10. If Alicia puts in a high effort (low effort) there is a 90% (10%) probability that revenue will be high and a 10% (90%) probability that revenue will be low. Assume that ex = 8 and e. = 2. However, they are not observable by Paul. Since the efforts are not observed, the wages offered by Paul do not depend on efforts, but they depend on the levels of revenue. If the revenue is high Alicia receives W. and if the revenue is low Alicia receives W. where WH > W. Assume there is no bonus. If a contract is rejected payoffs are (0,0). Draw the game tree. Write and explain the incentive compatibility constraint and the participation constraint. Draw the graphs of the two constraints maintaining them as inequalities. For the graph measure W along the horizontal axis and W. along the vertical axis. Determine the wages under the optimal contract. (the optimal contract will specify the two wages that will satisfy the above constraints). Show the optimal contract (the wage combinations) on the above graph. 1. Paul is planning to hire Alicia for a project. Both are risk neutral with linear utility functions. Paul's utility function is: Uz = R-W, where R is revenue and W the wage rate. Alicia's utility function is: U2 = W-e, where e is the level of effort. Alicia may put in a high effort, ex or a low effort, e_. Paul's revenue can be high RH = 20 or low RL = 10. If Alicia puts in a high effort (low effort) there is a 90% (10%) probability that revenue will be high and a 10% (90%) probability that revenue will be low. Assume that ex = 8 and e. = 2. However, they are not observable by Paul. Since the efforts are not observed, the wages offered by Paul do not depend on efforts, but they depend on the levels of revenue. If the revenue is high Alicia receives W. and if the revenue is low Alicia receives W. where WH > W. Assume there is no bonus. If a contract is rejected payoffs are (0,0). Draw the game tree. Write and explain the incentive compatibility constraint and the participation constraint. Draw the graphs of the two constraints maintaining them as inequalities. For the graph measure W along the horizontal axis and W. along the vertical axis. Determine the wages under the optimal contract. (the optimal contract will specify the two wages that will satisfy the above constraints). Show the optimal contract (the wage combinations) on the above graph
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started