game? Where is the welfare loss coming from? Can you think of ways Exercise 2: Intro to Contract Theory Amazon wants to hire Lisbeth, a skilled programmer, by offering her a contract. A contract specifies a wage w and a minimum level of effort e that the worker must provide. Lisbeth does not have to accept the contract. If she does, she can exert high effort e = ey or low effort e = ez. Lisbeth efforts affect Amazon's revenues. if Lisbeth accepts offer, and exerts e = CH TR(e) = if Lisbeth accepts offer, and exerts e = el. if Lisbeth refuses offer Lisbeth utility is wage - cost of effort: U = w - C(e) where C(e ) = 1 if e = CH 10.5 if Lisbeth accepts offer, and exerts e = el If she refuses the offers, her outside value is Uour = 0. The timing of the game is: 1. Amazon makes an offer (w, e). 2. Lisbeth accepts or rejects the offer. 3. If she accepts, she decides whether to exert low or high effort. a. Suppose first that Lisbeth's effort can be observed by Amazon, and it only pays the wage if Lisbeth exerts the required level of effort. Solve for the equilibrium of this game by backward induction to find the contract offered by Amazon, and the effort exerted by Lisbeth (or whether she refuses the contract). b. Suppose now Amazon cannot verify the level of effort exerted. What is the equilibrium contract? Where is the welfare loss coming from? c. Amazon can observe its revenues. Suppose now it offers an outcome-dependent contract: it pays a wage WL if TR = 1, or a wage WH if TR = 5. What WL and WH will Amazon offer? In your work, make sure highlight the participation constraint, and the incentive compatibility constraint