Many companies reward their managers based on profits so that the managers will make decisions to maximize profits. However, some companies are paying their managers based on sales or revenue, instead of profits, so their managers will make decisions to maximize revenue. For example, at Reebok, the former CEO Paul Fireman received a nickel for every pair of shoes sold.

a. Suppose that there are two existing firms in the market competing in quantity. Ignore market uncertainty and long-run competition. Firm B's manager is always paid based on firm B's profits. Firm A has been paying its manager based on profits but now changes to pay the manager solely based on revenue. Each manager chooses the production level (quantity) for his firm simultaneously. Is it possible for the above change in firm A's compensation system to increase firm A's profits? What are the direct effects and strategic effects on firm A's profit? Explain.

Direct Effect (Circle one):Positive Negative Strategic Effect (Circle one): Positive Negative Explanation (be brief and clear):

b. Now suppose that the two firms compete in price. Ignore market uncertainty and long-run competition. Firm B's manager is always paid based on firm B's profits. Firm A has been paying its manager based on profits but now changes to pay the manager solely based on revenue. Each manager chooses the price for his firm simultaneously. Is it possible for the change in firm A's compensation system to increase firm A's profits? What are the direct effects and strategic effects on firm A's profit? Explain.

Direct Effect (Circle one):Positive Negative Strategic Effect (Circle one): Positive Negative Explanation (be brief and clear):