Suppose that agricultural output y on a farm depends on the effort exerted by the tenant. Output is given by the function: y = ln(e) where e is the effort level . The tenant decides the amount of effort to exert and pays a marginal cost c per unit of effort. The owner of the farm receives a share of total output, with 0 1.

(a) What is the effort level exerted by the tenant when he has to pay a share to the landlord?

(b) What would be the first best level of effort; what would be the effort exerted by the tenant if he also owned the farm?

(c) What is the difference between the first best and the level of effort of the tenant? How does it depend on: (i) , (ii) the marginal cost c.

(d) Assume now that effort is observable, and rather than receiving a share of the total output, the landlord gets a share of total benefits. This means that the landlord receives of y ce. Write down the maximization problem of the tenant. Does the tenant exert the first-best level of effort? Explain the intuition behind this result. [5 points]