Economics 217 Spring 2010Problem Set 5(Answers to due in class Tuesday, April 6th, to be discussedquestions 1-2 Friday, April 9th; )please denote which recitation you plan to attend on Friday1. Consider a scenario where a risk neutral firm writes a contract with a risk averse worker. Theworker provides either low or high effort (or ). There are only two values for realized/œ/62output, a low value () and a high value (). Illustrate graphically, in an Edgeworth box, aBB0=scenario where if effort is contractable then the optimal contract specifies the worker provide higheffort, but if effort is not contractable then the firms settles to contract for low effort.2. Consider a writing an optimal insurance contract with a risk neutral insurance company risk aversedriver. The driver has income resources of , but faces damages equal to if in an accident TheC.insurance contract specifies a premium collected by the company each period, with a claim paid:Dto the driver by the company in the event of an accident.
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