Consider the following principal-agent problem where an agent can either work hard (eH= 5) or be...

 

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Consider the following principal-agent problem where an agent can either work hard (eH= 5) or be lazy (eL = 0). There are two possible profit outcomes: nH = 400 and TL = 100. The conditional probabilities of the profit levels are: f(nHjeH) = 0:6, f(nLjeH) = 0:4, f(nHjeL) = 0:1 and f(rLjeL) = 0:9. The agent's utility depends on wages and effort as follows: u(w; e) -pw-e, where w 2 0. Her reservation utility is u = 0. The principal is risk neutral and her payoff is P(T; W) = πt - W. (a) If the effort level is observable to the principal, what wage scheme should she offer the agent for each effort level? Also, what will be the optimal wage scheme? (b) If the effort level is not observable, what wage scheme should she offer the agent for each effort level? Also, what will be the optimal wage scheme? Consider the following principal-agent problem where an agent can either work hard (eH= 5) or be lazy (eL = 0). There are two possible profit outcomes: nH = 400 and TL = 100. The conditional probabilities of the profit levels are: f(nHjeH) = 0:6, f(nLjeH) = 0:4, f(nHjeL) = 0:1 and f(rLjeL) = 0:9. The agent's utility depends on wages and effort as follows: u(w; e) -pw-e, where w 2 0. Her reservation utility is u = 0. The principal is risk neutral and her payoff is P(T; W) = πt - W. (a) If the effort level is observable to the principal, what wage scheme should she offer the agent for each effort level? Also, what will be the optimal wage scheme? (b) If the effort level is not observable, what wage scheme should she offer the agent for each effort level? Also, what will be the optimal wage scheme?

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Lets analyze the principalagent problem step by step for both scenarios when effort is observable to the principal and when it is not a Effort Observa... View the full answer