A landlord maximises profit per worker which is pe -w where p=10 is the output price; e is the workers effort which determines output and e is the wage. The worker maximises utility u= w-e² , where e² is the disutility of effort. The landlord and worker agree on a specified level of effortat the beginning of the contract. If the landlord observes the worker exerting effort below the specified level they agree that the worker will not be paid.

(a)What will be the agreed level of effort and wage in the case where the employer can observe the workers effort and the worker has an alternative job offer that gives utility of 1.

Observed

(b)Now say that as long as the worker exerts effort above the level e0=2 the employer will not know what the level of effort is but if effort is below e0=2 the employer will observe the workers effort. That is there is some level of effort below which it will be obvious that the worker is shirking , but above this level the employer is not able to tell how hardworking the labourer is due to monitoring costs. The level of effort eo is less than the level of effort from the answer to part (a).What will the agreed level of effort and wage be in this case.

Unobserved