problem set 3

# problem set 3 - John Engel is a sales agent for ABC Company...

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John Engel is a sales agent for ABC Company. He has an effort cost function of C = e 2 and a reservation wage of \$1,500. His wage package is W = 1,500 + 0.2Q where the CEO sets the incentive at 0.2 and Q = 200e. Q is the output. If the CEO increases the incentive from 0.2 to 0.25, what happens to the John's effort? Will profits rise or fall? (20 points) Under the 0.2 incentive, effort is 20, and expected profits are 1,700. Resolving the problem under the higher incentive of .25, his marginal expected benefit is .25(200) = 50 and his optimal effort satisfies 50 = 2e or e=25. Therefore his effort increases. Expected output goes up to Q = 200(25) = 5,000. Expected wages are 1,500 + .25(200(25)) = 2,750. Expected profit will rise in this case to 2,250. Great Cars, Inc. faces the following demand function for its automobiles: P = 55,000 – 200 Q Its marginal cost (MC) is \$9,000. What will its price be if it decides to sell the automobiles by itself and what will the price be if it sells though DistriCorp, Inc. an independent distributor. Note that when Great Cars, Inc. contracts

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