QUESTION 1A risk neutral worker has a reservation wage of 500 and a cost of high effort of 160. Depending on the effort put by the worker andsome random luck factor, the employer will earn 2500 (if the worker puts high effort and he gets lucky), or 1500 (if the worker putshigh effort and he gets unlucky OR if the worker puts low effort and he gets lucky), or 500 (if the worker puts low effort and he getsunlucky). Assume the worker gets lucky with probability 0.6. The employer wants to incentivize the worker to put high effort anddecides to pay the worker an incentive contract comprised of a fixed wage of $500 plus a bonus paid only if the profit of 2500 isrealized. Calculate the optimal such bonus that the employer should pay, if it wants to incentivize the worker and maximize itsprofits at the same time. Round your answer to 2 decimals, if needed.QUESTION 2Assume that after buying insurance, drivers can choose to drive safely or drive recklessly. Driving safely or recklessly, each comewith their own benefits and costs for the driver, so they each have a different net benefot for the driver. Assume that driving safelybrings a net benefit to the driver of $200, while driving recklessly brings a net benefit to the driver of $500. Also, depending ondriving habits and also on luck, the driver will avoid or be engaged in accidents. If the driver drives safely and he is also lucky, heavoids getting into an accident. If he drives recklessly and he is lucky, he will experience a minor accident. The driver will alsoexperience a minor accident if he drives safely but he is unlucky. Finally, if the driver drives recklessly and he is also unlucky, he willget involved in a major accident. Assume a minor accident costs the insurance company 500, while a major accident costs them3000. Assume also that the driver is lucky with probability 0.78. The insurance company is designing an insurance contract to try tocorrect moral hazard problems and incentivize the drivers to drive safely by introducing a deductible in the contract. A deductible isa sum of money that has to come up from the driver's pocket in case of an accident, before the insurance company pays anything.So a deductible acts as a cost to the driver, if he has an accident (regardless if it's a minor or major accident). What should be theminimum deductible charged by the insurance company, to incentivize the driver to drive safely? Round your answer to 2 decimals,if needed.

Reservation wage = 500 Cost of high effort = 160

A risk neutral worker has a reservation wage of 500 and a cost of high effort of 160. Depending on the effort put by the worker and some random luck factor, the employer will earn 2500 (if the worker puts high effort and he gets lucky), or 1500 (if the worker puts high effort and he gets unlucky OR if the worker puts low effort and he gets lucky), or 500 (if the worker puts low effort and he gets unlucky). Assume the worker gets lucky with probability 0.6. The employer wants to incentivize the worker to put high effort and decides to pay the worker an incentive contract comprised of a fixed wage of $500 plus a bonus paid only if the profit of 2500 is realized. Calculate the optimal such bonus that the employer should pay, if it wants to incentivize the worker and maximize its profits at the same time. Round your answer to 2 decimals, if needed.

A risk neutral worker has a reservation wage of 500 and a cost of high effort of 160. Depending on the effort put by the worker and some random luck factor, the employer will earn 2500 (if the worker puts high effort and he gets lucky), or 1500 (if the worker puts high effort and he gets unlucky OR if the worker puts low effort and he gets lucky), or 500 (if the worker puts low effort and he gets unlucky). Assume the worker gets lucky with probability 0.6. The employer wants to incentivize the worker to put high effort and decides to pay the worker an incentive contract comprised of a fixed wage of $500 plus a bonus paid only if the profit of 2500 is realized. Calculate the optimal such bonus that the employer should pay, if it wants to incentivize the worker and maximize its profits at the same time. Round your answer to 2 decimals, if needed.

Managerial Economics: A Problem Solving Approach

5th Edition

ISBN:9781337106665

Author:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor

Publisher:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor

Chapter17: Making Decisions With Uncertainty

Section: Chapter Questions

Problem 8MC

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