Principle agent problem, Microeconomics

Assignment Help:

Principle Agent Problem [Dealing with hidden action]

Assume that the employer (principle) wants its employee (agent) to work hard [You can safely assume that this maximizes the principle's expected profits from his business]. There are two effort levels available, eL = 0 and eH = 2 . The effort level of the agent is not directly observable for the principle. Then the principle has to base his wage contract on the outcomes, year end profits for the firm. Two outcomes are possible, πH = 1000 and πL = 0. The outcome does not only depend on the effort level of the agent, but on the market conditions as well. But high effort level increases the chances of ending up with the good outcome. With high effort level probability of ending up with the good outcome πH is 0.9, and it is only 0.1 when the effort level is low.

1318_Principle Agent Problem.png

 

Agent's utility function is given as U (w,e) = W ½ - 4e  . Note that his utility depends negatively on the effort level he exerts; it is costly for him to exert effort _ it creates disutility. Agent's reservation utility is U0 = 1 by assumption, not getting the job he can stay at home and read all day and that worth 1 util for him. Put yourself in the place of the principle and design a wage contract for your agent. Again your aim is to exert high effort. Denote the wage payments agent receives when good outcome or when bad outcome is realized as wH and wL , respectively.

a. Indicate the condition that creates the incentive to exert high effort level for the agent [incentive compatibility constraint].

b. Indicate the condition that must hold for the agent to accept this contract [participation constraint or individual rationality constraint].

c. Determine the wage contract that would make the agent work and work hard [Go with the minimum possible wages, you want to maximize the profits].


Related Discussions:- Principle agent problem

Limitations of the services sector, Limitations of the Services Sector: ...

Limitations of the Services Sector: The services sector in India, as at present, suffers from low productivity and low quality in spite of fairly large investment in technolog

Explain perfect competition according to economics theory, Explain about th...

Explain about the perfect competition according to economics theory. The procedure of testing and refining theories is the key to the development of modern economics like a sci

Distinction between human capital and resource and manpower , Distinction b...

Distinction between Human Capital and Resource and Manpower Health and education are normally considered as human capital. Health includes both physical health and fitness. E

Mrs and mrts, compare marginal rate of technical substitution and marginal ...

compare marginal rate of technical substitution and marginal rate of substitution

Elasticity, -1- ASSIGNMENT #1 The demand function for Product X is given by...

-1- ASSIGNMENT #1 The demand function for Product X is given by: Qdx = 80- 2Px- 0.05P²x -0.2Py + 4Pz + 0.01I+ 2A Where: Px Price of good X $120.00 Py Price of related good y $100.0

Stoichiometry , Mg(OH)2 + 2HCl-----> MgCl2 +2H2O how many grams of magnesiu...

Mg(OH)2 + 2HCl-----> MgCl2 +2H2O how many grams of magnesium chloride can be produced from 14.60mL of a 0.546M hydrogen chloride solution?

Global business etiquette, Your company has a product that it is interested...

Your company has a product that it is interested in marketing in a foreign country. Using one of the following Websites, click on a country of your choice to learn about Etiquette,

Test, how much for taking a test

how much for taking a test

Law of mass action, Law of mass action states that at a constant temperatur...

Law of mass action states that at a constant temperature rate of a chemical reaction is directly proportional to product of active masses of the reactants raised to the power equal

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd