1. Static Moral Hazard Consider an agency relationship in which the principal contracts with the agent. The monetary result of the rela- tionship depends on both agent's effort and state of nature as follows: states: q1 q2 q3 resultwhene=6 x=60,000 x=60,000 x=30,000 resultwhene=4 x=30,000 x=60,000 x=30,000 Both parties believe that the probability of each state is one third. The payoff functions of the principal and the agent are give by B(x, w) = x w U(w, e) = pw e2, where x is the monetary result of the relationship and w is the wage received by the agent. Suppose that the agent will only accept the contract if he obtains an expected utility level of at least 114. 1. What would be the effort and the wage if effort is contractible? 2. What is the optimal contract when effort is not contractible? What wage scheme induces e = 4 at the mini- mum cost for the principal? What wage scheme induces e = 6 at the minimum cost for the principal? 3. Which effort level does the principal prefer when effort is not observable? Discuss