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ECOS3003 Final Exam

Question 1

Consider a game in which a principal P and and agen A simultaneously choose their actions. The principal's can choose to either delegate (D) or centralise (C). The agent can choose to either be lazy (L) or to work hard (H). The payoffs are as follows. If the P chooses D and the A L the payoffs are 7 to the principal and 6 to the agent. If the P chooses C and the A L, the payoffs are 1 to the Principal and 8 to the agent. If the P opts for D and the A H, the payoffs are 8 to the principal and 2 to the agent. Finally, if the choices of action are C and H by the P and A, respectively, the payoffs are 5 to the principal and 4 to the agent. Which of the following statements are true?

This is a prisoners' dilemma

There is a dominant strategy equilibrium.

The Nash equilibrium is (C, H)

There is a unique Nash equilibrium

The Nash equilibrium is (D, L)

This is not a prisoners' dilemma.

Question 2

A principal can choose to make the allocation of tasks broad (B) or narrrow (N). At the same time an agent can choose to work put in high effort (H) or low effort (L). The payoffs are 20 to the principal and 30 to the agent is the actions chosen are B and L. For all other combinations of actions the payoffs are 0 to both players. Which of the following statements are true?

A Nash equilibrium is (N, H)

There is no Nash equilibrium in pure strategies in this game.

A Nash equilibrium is (B, L)

A Nash equilibrium of the game is (B, H)

A Nash equilibrium is (N, L)

Question 3

A business wishes to hire a legal firm to provide some legal services. The marginal benefit to the business from the legal services is MB = 210 - q, where q is the quantity provided. The marginal cost to the legal firm is MC = 2q. The issue is that is difficult to contract on the quantity of legal services provided. The business can spend $50 on monitoring and the legal firm can spend $100 on a recording its efforts. Even with these expenditures, a court cannot distinguish the difference between a q = 50 and the efficient level of q. In this case, what is the total agency cost?

Question 4

Consider a simultaneous-choice game in which the principal can choose to delegate (D) or centralise (C) and a worker can opt for either low (L) or high (H) effort. The payoffs are (2, 3) if the choices are (D, L) to the principal and the agent, respectively. The payoffs are (5, 4) if the choices are (C, H). If either (C, L) or (D, H) are chosen, the payoffs are 0 to both players. If in the mixed strategy equilibrium, the principal plays D with probabilty a and the worker plays L with probability b, what is outcome in the mixed strategy equilibrium?

a = 2/5; b = 3/4

None of the other answers are correct.

a = 4/7; b = 5/7

a = 5/7; b = 4/7

a = 1/3; b = 3/7

Question 5

A buyer and seller trade with each other for an infinite number of periods. Both parties have a discount factor of d, where 0 < d < 1. In each period both parties can play trust (T) or to play selfish (S). If both the buyer and seller play T the payoffs are 4 to each player. If both parties play S the payoffs are 3 to each player. If one player plays S and the other T, the payoffs are 6 to the player who opted for S and 1 to the party that opted for T. Consider the following trigger strategy. In the first period play T. In any subsequent period, play T if in every previous period the outcome was (T, T), if not play S. What is the minimum d required for this trigger strategy to be subgame perfect equilibrium?

1/4

d

1/3

None of the other answers are correct.

3/4

Question 6

Which statement is true?

Bureaucratic wage-settine rules in response to influence costs tends to accentuate wage dispersion in an organisation.

Influence costs tend to encourage employers to set wages to employee's outside wage offers.

The use of bureaucratic wage-setting rules to avoid influence costs tends to mean that highly productive workers are paid too little.

None of the other answers are correct.

Bureacratic wage-setting rules established in response to influence costs discourage empire building.

Question 7

Consider a firm offering employees a compensation package that contains both a salary (money) and a fringe benefit of use of a company car. The government introduces a new payroll tax that requires employers to pay a tax based on the total salary bill of the firm. Which of the following statement is true?

A profit-maximising response of the firm is to increase value of the fringe offered to the employee, and to decrease the employee's salary

A profit maximising response would be to decrease the wage of the employee, but keep the fringe benefit unchanged.

A profit-maximising response to the payroll tax would be to reduce the fringe benefit to zero.

Given the employee's reservation utility (outside option) the firm is unable to change either the salary or the fringe benefit offered.

None of the other answers are correct.

Question 8

Which of the following statements is true?

None of the other answers are correct.

In the competitive-labour market model, employers would never make general human capital investments in their employees

In the competitive market model, an employee would never make investments in specific human capital.

In the competitive labour market model employers would never make specific human capital investments.

In the competitive labour market model both employees and employers would make both general and specific human capital investments.

Question 9

Which of the following statements are true?

An advantage of a specialised task allocation is that it enhances organisational flexibility.

An advantage of a specialised task allocation is that it reduces coordination costs across tasks.

None of the other answers are correct.

A disadvantage of a specialised task allocation is that it tends to increase the average wage bill.

An advantage of specialised task allocation is that lowers training costs

Question 10

Team decision-making in an organisation is more likely when:

The specific information relevant for a decision is dispersed amongst different individuals.

Potential team members have differing objectives.

Different individuals in an organisation share the same objective

There is process to expedite decisions in the case of disagreement on the course of action

A unanimous on the team is required for a decision to be implemented

Question 11

Considering the Aghion and Tirole model of formal and real authority studied in class, which statement is true?

None of the other answers are correct.

The principal is more likely to centralize decision making when her cost of effort is high and the agent has similar preferences to her.

A decision is more likely to be centralised when the principal has a high stake in the project and the preferences of the two parties are dissimilar.

Centralisation of formal authority is more likely when the agent's stake in the project is relatively large compared with the principal.

A decision is more likely to be centralised when the preferences of the principal are similar and the agent has a low cost of effort.

Question 12

There is a Principal and an agent, and the principal needs to decide on which project to implement. If the principal’s preferred project is implemented the agent gets b = 60 and the principal gets surplus of B = 100. If the agent’s preferred project is implemented the agent gets b = 80 and the principal gets a return of B = 50.

Ex ante all projects look alike; assume that if the principal is uninformed she will follow the recommendation of the agent. The principal can expend effort E to become informed. The principal can either expend effort E = 0, which will give her a zero probability of becoming informed. Alternatively, she can expend effort E = c at the cost of c, which will mean that she is informed with probability ½ (that is, she is informed with probability ½ if effort cost is c).

On the other hand, the agent can become informed at zero cost, so we can assume that he will always be informed.

The principal has a choice – she can retain formal authority to make the decision for herself (P-formal authority), or she can delegate the formal decision-making rights to the agent (delegation).

If the principal has P-formal authority she will try to be informed (expend effort E = c). With delegation she will not bother putting in effort (E = 0). Ignoring her ex ante effort costs E, the principal’s expected return U from P-formal authority is

and the her expected payoff from delegation U is

.

The highest value of effort cost c such that the principal will choose to retain formal authority is    .

Question 13

A union and a firm are in an on-going relationship that lasts for two periods. In each period there is a potential innovation that could increase total surplus; in the first period the innovation could generate $50; in the second period innovation could generate $90. Without innovation in either period both parties get 0.

Prior to any innovation occurring, the union can veto any proposed change; that is both parties need to agree to change for innovation to occur. When the union agrees to innovate for the first time it has some bargaining power so that it can capture one half of the surplus that the innovation generates. If innovation has occurred previously, the union has no bargaining power and gets none of the surplus from innovation.

The firm, for its part, can provide additional compensation to the union for agreeing to innovate. This compensation is a payment over and above the surplus that the union would get given their bargaining power.

What is the minimum amount of compensation the union needs in order for it to agree to change in the first period?

Question 14

Which statement is true?

A manager's organisational power tends to be enhanced by control over budgets.

A manager's organisational power tends to be enhanced if they have reputation for being untrustworthy.

A manager's organisational power relies solely on formal decision-making authority.

Logrolling is always a credible way to enhance a manger's organizational power.

Question 15

Which of the following statements is true?

a weak board is likely to be associated with CEO pay that is more sensitive to performance.

an increase in managerial power would be associated with a decrease in the sensitivity of executive remuneration to performance.

directors always act as the shareholders’ representative when negotiating CEO pay.

managerial power is increasing in the number of institutional shareholders.

protection from takeovers is likely to be associated with executive pay that is relatively sensitive to performance.

Question 16

Which statement is true?

In an investment centre, managers should be rewarded for on the basis of the rate-of return on assets.

Revenue centre managers cannot have control over both prices and the quantities sold.

None of the other answers are correct.

Decision making rights of a cost centre as the same as a revenue centre.

Profit centre managers should not have control over the prices of output of the centre.

Question 17

Which of the following statements is true?

U-form structures are associated with firms adopting a product-differntiation strategy.

The M-form is associated with decentralization of decision making.

The U-form structure allows for more experimentation across an organisation.

M-form are associated with stable markets and small firms.

U-form structures are more likely in unstable product-market environments.

Consider a workplace that has two workers who can work as a team. Each worker can put in effort; worker 1’s effort is labelled e1 and worker 2’s as e2. These effort choices are made simultaneously. Output of the team is 6e1 + 10e2. Each worker bears the cost of their effort and has a utility of Ui = wi – ei , where i = 1,2 and wi is the wage that the worker receives.

a. What are the first-best (surplus-maximising) efforts for each worker? (2 marks)

b. Now assume that the effort of each worker is unobservable but team output can be contracted on. In fact, assume that the balanced-budget rule holds in that each worker receives half of team output as their wage. What are the efforts that each workers put in. Explain the differences (or similarities) between your answer here and that for part a. Use a diagram to help explain your answer. (6 marks)

c. Assume now that one of the workers can become the ‘owner’ of the operation. The worker who owns the firm is able to keep all of the team output for themselves (each worker continues to bear their own cost of effort, regardless as to who is the owner and effort continues to be non-contractable). Consider the three possible ownership structures: worker 1 ownership; worker 2 ownership; and joint ownership, which is the same as part b (that is a 50:50 split of team output). Which is better and why? Relate your answer to the property-right model studied in class. (6 marks)

d. Outline the key intuition of the property-right model. What are the key predictions? What are the limitations of the model? (8 marks)

(Upload your scanned handwritten answer and submit via the Assignment folder.

Please submit one scan for answers Question 18, 19 and 20)

Consider a market in which there are two types of workers L and H. Each type of worker has a different level of productivity, but that productivity is unobservable ex ante to potential employers. Before seeking employment at a firm in the market, all workers can (if they choose) get some level of education e. This choice of education e is observable to all, including potential employers. Assume that the market is competitive, so expected profits must be zero in equilibrium.

The L-type workers have a productivity of 2 if they work for a firm in the market. They also have an outside option of 2. The utility function of the L-type workers UL = wL – eL, where wL is the wage received and eL is the level of education they obtain.

The H type worker has an outside option of 2 and a productivity of 4 if they are employed by a firm in the market. The utility function for a H-type worker is UH = wH – (1/3)eH, where wH is the wage paid to a H-type and eH is the education they choose to get.

productivity. With the aid of a diagram, explain your answer. What is the maximum level of education the H-types will choose to get in any separating equilibrium? Explain your answer. (7 marks)

b. Now assume that the utility function for the H-type workers is UH = (1/3).wH – (1/3)eH. Is there a separating equilibrium? If so, find it. If not, explain why. (3 marks)

(Upload your scanned handwritten answer and submit via the Assignment folder. Please submit one scan for answers Question 18, 19 and 20)

Consider a firm – Gizmos Inc - with two profit centres, A and B. In the firm, profit centre A makes one input at a marginal cost of $20 which it transfers for a price t to profit centre B.A is the only source of the input. B transforms one unit of input into one unit of output at zero marginal cost and sells as a monopolist into a market with a demand curve of P = 120 – q, where P is price and q the quantity of output.

a. If both A and B act together to maximise profit for the firm, what is the final price, output and profit for the firm.? (2 marks)

b. Now assume that each profit centre acts to maximise its own profit. What is the transfer price t, the final output and price charged by B and the profit generated by both profit centres? What is the total profit generated by the firm? Explain the differences between your answer in part a with your answer here. Use a diagram to help provide some intuition. (4 marks)

c. Devise a transfer pricing scheme that allows a firm that maximises firm profit. Assume that A and B have equal bargaining power, so they will share any profit generated equally. Explain your scheme. (4 marks)

(Upload your scanned handwritten answer and submit via the Assignment folder. Please submit one scan for answers Question 18, 19 and 20)