ECOS 2201 Economics of Strategy and Competition Semester 2, 2022
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ECOS 2201 Economics of Strategy and Competition
Semester 2, 2022
Problem Set 1
1. Plot the following incentive contracts with out put y on the horizontal axis and wages on the vertical axis.
(a) s = 5, b = 0.4.
(b) s = 0, b = 0.8.
(c) s = -1, b = 1. How would you interpret the negative salary in this case?
2. A stock option is an incentive contract, which allows a worker the option to buy stock at a pre-specified exercise price K . Let y be the stock price of the firm. Specify the worker’s wage with this incentive contract. Plot it.
3. Consider a setting with a worker and a firm. The worker exerts an effort level a which is unobservable to the firm and his effort cost is given by C(a) = ca2 with c > 0. Total output is given by y = ka with k > 0. Firms offer workers a take it or leave it wage contract of the form w = s + by . Assume that the firm maximizes profits and the worker maximizes his utility given by w - ca2 . The workers outside option is u0 .
(a) Set up the maximization problem (write down the objective function,
constraints and choice variables) for a firm.
(b) Compute the efficient level of effort.
(c) Compute the firms optimal choice of b, and a when c = 1 and k = 1 and u0 = 0.
(d) Compute the firms optimal choice of b, and a when c = 1 and k = 2 and u0 = 0. Compare your answers in part (c) with part (d).
(e) Consider a regulation where the salary of the agent has to satisfy s 2 0.
Redo parts (a), (b) and (c) above taking this regulation into account.
4. The following link is from a radio show called Planet Money.
https://www.npr.org/sections/money/2009/07/hear_how_we_get_paid.html Listen to the first 10 minutes or so. Think of a few examples of jobs that you are familiar with and how workers are motivated in these jobs.
2022-08-09