Asymmetric_info_sol

# Asymmetric_info_sol - UBC COMM/FRE 295 Solution to Practice...

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1 UBC COMM/FRE 295 Solution to Practice Problem Asymmetric Information 1. A firm’s short-run revenue is given by R = 10e - e 2 , where e is the level of effort by a typical worker (all workers are assumed to be identical). A worker chooses his level of effort to maximize his wage net of effort w - e (the per-unit cost of effort is assumed to be 1). Determine the level of effort and the level of profit (revenue less wage paid) for each of the following wage arrangements. Explain why these differing principal-agent relationships generate different outcomes. a. w = 2 for e 1; otherwise w = 0. There is no incentive for the worker to provide an effort that exceeds 1, as the wage received by the worker will be 2 if the worker provides one unit of effort but will not increase if the worker provides more effort. The profit for the firm = R – w = (10)(1) - 1 2 - 2 = \$7. In this principal-agent relationship there is no incentive for the worker to increase his or her effort beyond e =1 as the wage is not related to the revenues of the firm.

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