Question

E.E. T - abe * A Ă Aa A * Aay. A U . AaBbCcDc AaBbCcDc AaBbc 1 Normal T Normal 1 No Spac... Heading 1 O Fin be Reg W Sele Editing Font Paragraph Styles 45-u, 20-5 High Effort Accept Otetu Low Effort 25-w, 2-4 Reject Don't Offer 0,0 0.0 Figure 2: A principal agent problem. What will the agent do in Figure 2. If the principal offers a fixed-wage of w = 25. Given that the principal (P) must offer the agent (A) a fixed wage contract at wage w. or offer no contract at all? The principal should offer a wage (W) above what to maximize his own pavoft? From the principal's perspective, what is the best wage offer at low and high effort suppose the principal (P) offer the agent (A) a contract with the wage conditional on the agent's effort. ho

Answer 1

ris fw = 25, Game becomes A High Elfort (20,45) Poften Auge Lowelfort (0,46) Don't L A Rejet 00 oggen (oo) solving Backwards: Agent @ terminal nade deciding between, lighs Effort" & "low effort", chooses how effort bez 46 745. Agent chooses b/w (Accept, Reject and chooses Accept since 4630 Principal @ the beginning node is indifferent between offering & not offering since he gets a payoff = 0 from either action given w=rs. Thus Principal es may or may not offer a fixed wage contract wags. He is equally well-off in both cases. (ii) To maximize his own payoff, Principal must offer wage so that Agent (ginen his behavious) where we chooses to exert low effort) is e ? indifferent between Accepting & Rejecting the wage payoff to Agent on Accepting wage we 2w-4 payoff to Agent on Rejecting = 0 2 2W-4 = 0 = 2W = 4 a {w=2) Thas to makinize his own payoff choose to offer (W=2 A Principal should in

- 2 2 (ii) how effort & As from the part (8) ſw=2] High Effort. 90-5=0 - 5/2 = 2.5 Tw=2.5 is the best wage to offer @ Nigh effort case.