The revenue generated by an employee in a firm is either $5,000 or zero. The probability of generating $5,000 of revenue depends on whether the employee exerts effort and works hard or whether he shirks and does not exert any effort If the employee works hard, there is a 60% probability that the firm makes $4,000 in revenues. Whereas if he shirks, this probability decreases to 10%. The table below shows the probabilities in each case: Revenue High Effort, H Low Effort, L $5,000 0.6 0.1 $0 0.4 0.9 ai Assume the following: The employee's cost of effort is $200. The reservation wage is $0. Both employee and firm are risk-neutral. The market supply of labor is competitive, so that the employee is paid the lowest possible wage that will make him accept the employment. . Compensation with Observable Effort First assume that the firm can observe and enforce the employee's effort and it offers an employment contract (w, $200), where the employee receives a wage of w if he exerts effort and a wage of $200 if he does not exert effort. a) What is the lowest w that will get the employee to accept the employment and exert high effort? Denote this wage by w. (1 points) Consider the employment contract (w, $200). b) What are the expected profits to the firm? (2 points) c) What is the employee's surplus? (2 points) d) What is the total surplus? (1 point) The revenue generated by an employee in a firm is either $5,000 or zero. The probability of generating $5,000 of revenue depends on whether the employee exerts effort and works hard or whether he shirks and does not exert any effort If the employee works hard, there is a 60% probability that the firm makes $4,000 in revenues. Whereas if he shirks, this probability decreases to 10%. The table below shows the probabilities in each case: Revenue High Effort, H Low Effort, L $5,000 0.6 0.1 $0 0.4 0.9 ai Assume the following: The employee's cost of effort is $200. The reservation wage is $0. Both employee and firm are risk-neutral. The market supply of labor is competitive, so that the employee is paid the lowest possible wage that will make him accept the employment. . Compensation with Observable Effort First assume that the firm can observe and enforce the employee's effort and it offers an employment contract (w, $200), where the employee receives a wage of w if he exerts effort and a wage of $200 if he does not exert effort. a) What is the lowest w that will get the employee to accept the employment and exert high effort? Denote this wage by w. (1 points) Consider the employment contract (w, $200). b) What are the expected profits to the firm? (2 points) c) What is the employee's surplus? (2 points) d) What is the total surplus? (1 point)
