Question: An employer hires a worker to do a job.Profits for the employer will be eitherHorL<H. The probability of high profits is a function of the worker's choice of effort.If the worker chooses high effort, high profits will occur with probability ph, but it the worker chooses low effort the probability of high profits is pl; 0 <= pl < ph <=1.

The worker's utility is defined over the wage paid and the level of effort. This utility is represented by a function u(w) = u(wj) - dj, j = l,h, where u( ) is increasing and concave and dl < dh. The worker has a reservation utility of z > 0.The employer is risk neutral, so utility is given by the difference between profits and the wage paid; the employer's reservation utility is zero. Assume that the employer has all the bargaining power.

Suppose that the worker's effort is not observable but pl = 0 and ph = 1.

a) What contract will the worker be offered if the employer wants to the worker to provide high effort?Explain briefly.

**Now suppose that 0 < pl < ph < 1.Effort is still unobservable.Supposeu(w)is linear.**

b) Will a contract of the type you described in (a) be optimal for the employer?Why or why not?

c) What conditions must be satisfied for the worker to provide high effort?Why?

d) Derive the best contract for the employer which elicits high effort from the worker.