Determine which contract Paul would prefer if Amy’s cost of normal effort is 10 instead of 0 in the spreadsheet in Q&A 15.4.

Q&A 15.4.

Paul wants to hire Amy to manage a shop he owns. He is considering three different payment contracts: a fixed wage of 100, a 25% profit share, and a 30% profit share. If Amy provides normal effort, the shop earns 200 with bad luck and 600 with good luck. If Amy provides high effort, the shop earns 600 with bad luck and 900 with good luck. The chance of bad luck is 40% and of good luck is 60%. Amy incurs a personal cost of 90 if she provides high effort but incurs no personal cost for normal effort. Assume that both Paul and Amy are risk neutral and therefore want to maximize their expected payoffs. Set up a spreadsheet as shown and use it to determine which contract would maximize Paul’s expected payoff.

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A D E F 1 Effort Level Bad Luck Good Luck EV Effort Cost Payoffs Fixed Wage 25% share 30% share 2 Normal 200 б00 Amy Amy 3. High 600 900 90 4 Paul