Principle agent problem, Microeconomics

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].

Posted Date: 3/2/2013 5:33:59 AM | Location : United States







Related Discussions:- Principle agent problem, Assignment Help, Ask Question on Principle agent problem, Get Answer, Expert's Help, Principle agent problem Discussions

Write discussion on Principle agent problem
Your posts are moderated
Related Questions
economists would predict that if salaries increased for engginieers and decreasded for mba braduates that fewer people would go to graduate school in business and more would go in

What is hyper inflation? How it can be reduced?   Hyper inflation means that prices of the consumable goods are very high. Prices can be decreased by supplying more goods in th

Consider the model of corruption explored by Shleifer and Vishni’s where there is one government-produced good X. There is a demand for that good described by the inverse demand eq

CURRENCY UNIONS AND OPTIMUM: This Section explains the working of monetary unions and common currency areas. The Section also examines the case for and against optimum currenc

Production without capital is hard for us even to imagine. Nature cannot furnish goods and materials to man unless he has the tools and machinery for mining farming forestry fishin

Economic Growth: Economic Growth refers to an increase in real aggregate output (real GDP) reflected in increased real per capita income. A country is said to experience econo

Suppose that two wage regressions are estimated for native and white workers: Wn = 5.0 + 0.10S Ww = 6.0 + 0.14S Pick a reasonable average level of schooling for white and Native wo

diagram of extension and contraction in demand?

evaluate each in term of strength and weakness relative to their applicability to asian economy situation or reality ,2. philippines economy situation or reality