Part 1 A drinks manufacturer introduces a new soft drink and negotiates contract terms with an advertiser for a multimedia campaign to promote it. If the drink is a success, the manufacturer will make revenue of $100 mils. If the drink flops the manufacturer will lose $20 mils. If the advertiser puts her highest effort in the promotion campaign targeting different demographic groups and running clever adverts, the probability of success of the drink is 60%, A campaign with a lot of effort costs the advertiser f5mils. Without such effort the probability of success is 30%. The manufacturer cannot observe the effort of the advertiser. The manufacturer proposes the following compensation to the advertiser: Either a flat fee of 10mils, or a basic fee of f2mils and a 12% share of the revenue if the revenue is f100 mils. (a) Which of the two types of contract will the advertiser accept? (b) Will the advertiser put her highest effort? (c) What share of profits would motivate the advertiser to put the highest effort? Part 2 - Answer both questions 2.A Why substitution of capital into labour decreases transaction costs? 2.B Why asset specificity increases transaction costs