The city council of Comedyville has decided to give the towns theater to a private artistic director for managing. Artistic Directors come in two types, High ability, producing profits of 1000, and Low Ability, producing profits for just 600. There is no other factor affecting output other than the ability of the artistic director. The city council does not know the true ability of prospective artistic director, but it knows that with probability 12 she has high ability. The reservation income for managers is 100.

a. Suppose first that the city council is considering offering a contract in which the artistic director pays a fixed rent R to the Town, and keeps all the rest of the profits. Compute the rent charged by the city council.

Assume now that the city council contemplates offering two contracts and lets the artistic director choose one: a contract with a fixed-rent R and a contract specifying that a share 1 of the theaters profits should go to the town

b. Write the incentive-compatibility constraints and the participation constraints

c. Find the optimal contract (R, ).

d. Find the expected earnings for the town of Comedyville from the optimal contract, and compare it with the case at point a. of a fixed-rent contract.