Scenario 17.5 Consider the following information: Income to the firm from workers who sell door-to-door Bad Luck Good Luck Low Effort (e = :0) $5,000 $7,000 High Effort (e = 1) $7,000 $13,000 Cost of effort: c = $2500e Probabilities: Bad luck = .75; Good luck = .25 A principal-agent problem arises in the situation in Scenario 17.5 because: O the principal can measure effort and output; the agent can measure only output. O the principal can measure only effort, and the agent can measure only output. the principal can measure only output, and the agent can measure effort and output. neither the principal nor the agent can measure effort. O neither the principal nor the agent can measure output.
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- Suppose that the expected value of weekly profits for an ice cream shop, before paying the manager, Amy, is where e is Amy's weekly avertime hours. Amy is risk-neutral but incurs a cost for working overtime. Thus, tatal expected surplus is What level of effort maximizes total surplus? The value of overtime that maximizes total surplus is e-hours. (Enter your response rounded to one decimal place.) E(x)=500+10c C(e)=² E(S)-[(x)-C(e).A plaintiff believes that there is a 30% chance that he will winIf he wins, he will gain $50,000. It costs him $5000 in non‐recoverable litigation costs to take the case to court. If the plaintiff is risk‐neutral, which of the following is true? A) The plaintiff will take the case to court with an expected net‐gain of $10,000 B) The plaintiff will take the case to court with an expected net‐gain of $15,000 C) The plaintiff will not take the case to court because he is afraid of losing. D) None of the above5. Shift-in-charge Nazar Al Rushdy: Nazar is pessimistic about the market price. What is your guidance for Nazar? The decision to employ decision trees in crucial situations has been taken by Salem Al Harthi, the plant manager. The table below presents data on demand for a duration of 6 hours along with their respective probabilities. The first row of the table provides the probability of demand for the initial three hours when a leak occurs, denoted in parentheses. Subsequently, the following three rows indicate the probabilities of high, medium, and low demand for the succeeding three hours. To illustrate, if the initial 3-hour market price was low, the probabilities of high demand, medium demand, and low demand in the next three hours are 0.2, 0.3, and 0.5, respectively. Market price High Market price Medium Initial 3-hrs (0.2) Initial 3-hrs (0.5) Market price Low Initial 3-hrs (0.3) High demand (next (0.5) (0.4) (0.2) 3 hrs) Medium demand (0.3) (0.2) (0.3) (next 3 hours) Low demand…
- Reactors `R’ Us operates a nuclear power plant in Potsdam.In the event of reactor failure, there would be major damages to the North Country. The company can reduce the probability of failure through proper maintenance of the facility. The marginal cost of maintenance is increasing in the amount of maintenance done (and thus decreasing in the probability of an accident). We can write this marginal cost curve as MAC=2-10p (where 0<p<1, and represents the probability of a failure over a 50 year period). The marginal expected damages are an increasing function of the probability of an accident so that MD=2.2+10p. Provide a graph or graphs to illustrate your analysis/answers to the following questions. A. What is the efficient probability of reactor failure? B. If “Reactors ‘R’ Us” thinks that, in the event of reactor failure, they will NOT be found liable for damages, what probability of failure will they choose? C. If “Reactors ‘R’ Us” thinks that, in the…Define the term Aggregating Risk over time?If an individual is involved in an activity where their MB > MC, then they will immediately stop their behavior because at this point the activity is is harmful to them. True or False True False
- 3. A risk-neutral principal hires an agent to work on a project at wage w. The agent's utility function is: v(w)-g(e), where v(w)= Jw and g(e)=e/2 The agent can choose one of two possible effort levels, e¡ = 4 or e, = 6 . If the agent chooses effort level e, = 4 the project yields 100 with probability 1/4 and 0 with probability 3/4. If he chooses e, = 6 the project yields 100 with probability ½ and 0 with probability ½. The reservation utility of the agent is 0. (a) Suppose the effort level chosen by the agent is observable by the principal. Find the contract chosen by the principal. Show graphically in terms of contingent utilities v(w,00) and v(w.)QUESTION 1 A risk neutral worker has a reservation wage of 500 and a cost of high effort of 160. Depending on the effort put by the worker and some random luck factor, the employer will earn 2500 (if the worker puts high effort and he gets lucky), or 1500 (if the worker puts high effort and he gets unlucky OR if the worker puts low effort and he gets lucky), or 500 (if the worker puts low effort and he gets unlucky). Assume the worker gets lucky with probability 0.6. The employer wants to incentivize the worker to put high effort and decides to pay the worker an incentive contract comprised of a fixed wage of $500 plus a bonus paid only if the profit of 2500 is realized. Calculate the optimal such bonus that the employer should pay, if it wants to incentivize the worker and maximize its profits at the same time. Round your answer to 2 decimals, if needed. QUESTION 2 Assume that after buying insurance, drivers can choose to drive safely or drive recklessly. Driving safely or recklessly,…A risk-neutral firm produces chemical products, and its objective is to maximize expected profit. There is a risk that there will be an accident during the production process, and dangerous chemical products will be released into the ocean, polluting the water. To reduce the risk of an accident, the firm can choose Low or High investment in safety. Low Investment in Safety_ Cost for firm= $0 Probability of an Accident = 80% Probability of No Accident =20% High Investment in Safety Cost for firm= $150 Probability of an Accident = 20% Probability of No Accident = 80% The Government wants to reduce the risk of an accident, but the Government cannot observe the fir m's investment in safety. Therefore there is a moral hazard problem. However, the Government can observe whether an accident occurred or not. So the government decides to create a fine (penalty): if an accident occurs, the firm must pay a fine F to the Government. If an accident does not occurs, then the firm does not have to…
- In which of the following situations would the supplier have the greatest power to hurt a business that is its customer? a: The business could use an alternative input mix that uses significantly less of the supplier's product. b: The supplier rents building space to a bakery in a real estate market with a vacancy rate of less than .5%. c: The cost for the business to switch to a different supplier is low. d: The supplier is one of 100 companies selling the input needed by the business6 (A) Sudesh invests in the business which will give him a return of 64 if it turns out to be successful, and Rs. 36 if it is a failure. The probability of failure is 2/3 and that of success is 1/3. The utility function derived from the wealth from this business is given by u(w) = w?. Suppose the insurance company offers to insure Sudesh against low earnings. The price of the insurance is 75 paisa for each rupee of benefit. How much of the insurance will she buy to maximize his utility?Economics A risk neutral worker has a reservation wage of 500 and a cost of high effort of 187. Depending on the effort put by the worker and some random luck factor, the employer will earn 2500 (if the worker puts high effort and he gets lucky), or 1500 (if the worker puts high effort and he gets unlucky OR if the worker puts low effort and he gets lucky), or 500 (if the worker puts low effort and he gets unlucky). Assume the worker gets lucky with probability 0.4. The employer wants to incentivize the worker to put high effort and decides to pay the worker an incentive contract comprised of a fixed wage of $500 plus a bonus paid only if the profit of 2500 is realized. Calculate the optimal such bonus that the employer should pay, if it wants to incentivize the worker and maximize its profits at the same time. Round your answer to 2 decimals, if needed.