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Q. Effort level E of an employee cannot be observed by employer but it is known that it leads to employer's additional profit of 8E with probability 0.2 and to zero additional profit with complementary probability.
a. Discuss type of interaction, described in this question and resulting problemsfrom managerial point of view.
b. Design a wage-bonus package (w,b) for this employee, which maximizes expectedadditional profit of employer, if expected utility function of employee takes form u = w + b*1.6E - E*E - 0.2. Note that bonus b specifies proportion of additional profit that accrues to employer. Wage w is paid independently of amount of additional profit.
c. Provide optimal wage-bonus package, compute this employees' effort, expected payoff and employer's profit.
d. Draw a game tree for employer-employee game in parts a-c.
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