10-26-09 - Economics 448 Class Notes 10/26/09 A contract...

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Economics 448 – Class Notes – 10/26/09 A contract – paying someone some sum of money based on a signal you get from that person See someone doing nothing paid nothing See someone doing a lot of work paid a lot Wage could be the function of work effort Wage could also be the function of the outcome some signal of work effort by proxy (looking at number of shoes produced) When wage is based on outcome, agent has to bear more risk process of incentivizing people also involves RISK Incentives and risk go hand and hand #5 on worksheet Firm makes a decision I am going to pay someone. Do I want to pay someone so that they put in a low level of effort or HIGH level of effort On back of worksheet, you want people to put in the high level of effort Principal wants people to put in high effort Minimize the amount of money paid to the agent based on two constraints: 1. Participation constraint 2. Incentive constraint So, this is HOW WE GET THE OBJECTIVE CONSTRAINT:
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10-26-09 - Economics 448 Class Notes 10/26/09 A contract...

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