Question 1

Use the following profit function (per worker)for the Blue Delta Faucet Company to answer this question. P(e)= 40e - (2e² + 100) Note that P = firm profits and e = worker-hours per day.Assume that effort is observed perfectly.What is the profit-maximizing level of effort for the firm to set for workers?

Accepted Answer

D

Question 2

Use the following profit function (per worker)for the Blue Delta Faucet Company to answer this question. P(e)= 40e - (2e² + 100) Note that P = firm profits and e = worker-hours per day.Assume that effort is observed perfectly.At this profit-maximizing level of effort for the firm,profits per worker will be:

Accepted Answer

B

Question 3

The principal-agent problem occurs as a result of:

Accepted Answer

The principal-agent problem arises from the separation of ownership from management, where the owners (principal) delegate decision-making authority to the managers (agents) who may have different objectives and incentives than the owners. This can lead to conflicts of interest and a misalignment of goals between the two parties.

Question 4

Suppose that Wilma's utility function is given by U(E)= 100 - 2E², Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.If Wilma is forced to work an 8-hour day producing homemade dinners,her total utility will be:

Accepted Answer

Wilma's utility function is U(E)= 100 - 2E². If she is forced to work an 8-hour day producing homemade dinners, her total utility will be U(8)= 100 - 2(8)²= 100 - 128= -28.

Question 5

If effort is unobservable and revenues are riskless,firms can design incentive-compatible compensation schemes by offering workers:

Accepted Answer

Profit sharing allows workers to directly benefit from their efforts to increase revenues, creating a strong incentive for them to work hard and efficiently. Additionally, because revenues are riskless, there is no downside risk to profit sharing arrangements. Increased nonmonetary benefits or fixed salary can create some incentive, but workers may still lack motivation to perform at their highest level since they do not directly benefit from increased revenues. Decreased effort requirements or increased future compensation in the form of retirement pay would not address the issue of unobservable effort or provide any direct incentive for workers to increase revenues.

Question 6

Suppose that Wilma's utility function is given by U(E)= 100 - 2E², Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.Given her utility function,Wilma has an incentive to supply:

Accepted Answer

Wilma's utility decreases as her work effort increases, as indicated by the negative coefficient (-2) in front of the effort variable (E) in her utility function. This means that as she works harder (increases E), her utility (satisfaction or happiness) decreases, giving her an incentive to supply minimum effort.

Question 7

A manager has a utility function U = C ^0.5 if she doesn't work hard and U = C ^0.5 - 1 if she does.Expected profit will increase from 1,400 to 1,600 if she works hard.The manager receives compensation C equal to 82 plus a portion x of any profit in excess of 1,400.What is the value of x that will make the manager indifferent between shirking and working hard?

Accepted Answer

To make the manager indifferent, set the utility of working hard equal to the utility of not working hard: (82 + x*200)^0.5 - 1 = 82^0.5. Solving for x gives x = 0.095.

Question 8

The moral-hazard problem occurs when:

Accepted Answer

The moral-hazard problem occurs when a consumer of insurance changes behavior in a way that increases the likelihood of a claim, often because the risk is borne by the insurer.

Question 9

A manager has a utility function U = C ^0.5 if she doesn't work hard and U = C ^0.5 - 1 if she does.Expected profit will increase from 1,500 to 1,600 if she works hard.The manager receives compensation C equal to 81 plus a portion x of any profit in excess of 1,500.What is the value of x that will make the manager indifferent between shirking and working hard?

Accepted Answer

The answer of A manager has a utility function U...

Question 10

A technique for dealing with the principal-agent problem is to:

Accepted Answer

Requiring managers to purchase shares of stock in the firm aligns their interests with those of the shareholders, as they will benefit financially from the success of the company. Establishing a profit-sharing plan gives managers an incentive to increase the profits of the firm, as they will directly benefit from any increase in profits. Year-end bonuses based on profits similarly provide an incentive for managers to focus on increasing the profitability of the firm. All of these methods can help mitigate the principal-agent problem by aligning the interests of managers with those of the shareholders.

Question 11

A manager has a utility function U = C ^0.5 if she doesn't work hard and U = C ^0.5 - 3 if she does.Expected profit will increase from 1,000 to 1,500 if she works hard.The manager receives compensation C equal to 144 plus a portion x of any profit in excess of 1,000.What is the value of x that will make the manager indifferent between shirking and working hard?

Accepted Answer

The manager's utility from shirking is U = C^0.5 = (144)^0.5 = 12.Her utility from working hard is U = C^0.5 - 3 = (144 + 150x)^0.5 - 3.Setting these two utilities equal, we get:(144 + 150x)^0.5 - 3 = 12(144 + 150x)^0.5 = 15144 + 150x = 225150x = 81x = 0.162

Question 12

Suppose that Wilma's utility function is given by U(E)= 100 - 2E², Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.The marginal utility of effort for Wilma is:

Accepted Answer

The answer of Suppose that Wilma's utility function is given...

Question 13

Creditors and shareholders may have an incentive incompatibility because:

Accepted Answer

Shareholders have limited liability, meaning they can declare bankruptcy and not be personally liable beyond their investment, which can lead to riskier decisions that may not align with creditors' interests.

Question 14

Incentive-compatible employment contracts exist when:

Accepted Answer

Incentive-compatible employment contracts exist when the incentives of owners and managers are compatible with, though not necessarily the same as, one another. This implies that a balance must be struck between the interests of workers and the interests of managers and owners, and that incentives must be designed so that both parties benefit in the long-run. The other choices do not accurately describe incentive-compatible employment contracts.

Question 15

The savings and loan crisis of the early 1990s was caused by a moral-hazard problem because:

Accepted Answer

The moral-hazard problem refers to the fact that individuals or institutions may take on more risk than they would have without insurance protection, as they are protected from the full consequences of their actions. In the case of the savings and loan crisis, the government insurance provided by the Federal Savings and Loan Insurance Corporation (FSLIC) encouraged bank managers to take on more risk, as they were protected from losses if their investments failed. This led to a large number of risky loans and investments, which ultimately caused many banks to fail and required a costly government bailout.

Question 16

Use the following profit function (per worker)for the Blue Delta Faucet Company to answer this question. P(e)= 40e - (2e² + 100) Note that P = firm profits and e = worker-hours per day.Assume that effort is observed perfectly.At the profit-maximizing level of effort for the firm,daily per-worker compensation will be:

Accepted Answer

To find the profit-maximizing level of effort, take the derivative of the profit function P(e) = 40e - (2e^2 + 100) with respect to e, set it to zero, and solve for e. The derivative is 40 - 4e. Setting it to zero gives 40 = 4e, so e = 10. Substitute e = 10 back into the profit function: P(10) = 40(10) - (2(10)^2 + 100) = 400 - (200 + 100) = 100. However, the question asks for daily per-worker compensation, which is the total revenue per worker (40e) minus the cost (2e^2 + 100). At e = 10, compensation is 40(10) = 400, and cost is 200 + 100 = 300, so compensation is 400 - 300 = 100. Therefore, the correct answer is $300.

Question 17

Donald has a beach house on the Outer Banks of North Carolina that was severely damaged in the most recent hurricane to strike the coast.Due to beach erosion,he has rebuilt twice in the past 20 years.He is intent on rebuilding,confident that government-provided flood insurance will cover his expenses.This is an example of:

Accepted Answer

Donald's behavior is an example of moral hazard, which refers to the tendency for people to take on greater risk knowing that they are protected from the negative consequences. In this case, Donald is willing to rebuild his beach house in a location vulnerable to hurricanes and erosion because he knows that he is protected by government-provided flood insurance. This can lead to inefficiencies in the market and a higher cost for taxpayers as the government is forced to bear the cost of repeated damages.

Question 18

Principal-agent problems can exist between:

Accepted Answer

Principal-agent problems can exist between any two parties where one party (the agent) is acting on behalf of another party (the principal) and has the potential to make decisions that affect the principal's welfare. In the context of a business, this can occur between workers and managers, workers and owners, and owners and customers.

Question 19

Optimal employment contracts for managers,given revenue risk and unobservable output,consist of:

Accepted Answer

The optimal employment contract for managers in the given scenario would be a combination of a flat salary and a profit share related to the firm's overall success. This is because revenue risk and unobservable output make it difficult to measure individual effort accurately, and tying compensation directly to individual effort may lead to adverse incentive effects. However, a profit share that is indirectly related to individual effort can still provide motivation for managers to work towards maximizing the firm's profitability and value. A flat salary provides a baseline compensation for managers, which ensures some stability in their income and helps to attract and retain talent.

Question 20

Consider Mr.Ed,who purchases an insurance policy on a thoroughbred that he has acquired.He then proceeds to run the horse even though the horse has tendinitis.This is an example of:

Accepted Answer

Mr. Ed's behavior represents a moral hazard problem. Moral hazard refers to the idea that insurance can change the behavior of the insured, leading them to take risks they would not otherwise take because they are protected against the financial consequences of their actions. Despite knowing that the horse has tendinitis, Mr. Ed still decides to run the horse, which is a risky behavior that he might not have taken if he did not have insurance.

Quiz 15: Principalagent Issues and Managerial Compensation

The principal-agent problem occurs as a result of:

Suppose that Wilma's utility function is given by U(E) = 100 - 2E², Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.If Wilma is forced to work an 8-hour day producing homemade dinners,her total utility will be:

If effort is unobservable and revenues are riskless,firms can design incentive-compatible compensation schemes by offering workers:

Suppose that Wilma's utility function is given by U(E) = 100 - 2E², Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.Given her utility function,Wilma has an incentive to supply:

The moral-hazard problem occurs when:

A technique for dealing with the principal-agent problem is to:

Suppose that Wilma's utility function is given by U(E) = 100 - 2E², Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.The marginal utility of effort for Wilma is:

Creditors and shareholders may have an incentive incompatibility because:

Incentive-compatible employment contracts exist when:

The savings and loan crisis of the early 1990s was caused by a moral-hazard problem because:

Principal-agent problems can exist between:

Optimal employment contracts for managers,given revenue risk and unobservable output,consist of:

Consider Mr.Ed,who purchases an insurance policy on a thoroughbred that he has acquired.He then proceeds to run the horse even though the horse has tendinitis.This is an example of:

Quiz 15: Principalagent Issues and Managerial Compensation

The principal-agent problem occurs as a result of:

Suppose that Wilma's utility function is given by U(E) = 100 - 2E2, Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.If Wilma is forced to work an 8-hour day producing homemade dinners,her total utility will be:

If effort is unobservable and revenues are riskless,firms can design incentive-compatible compensation schemes by offering workers:

Suppose that Wilma's utility function is given by U(E) = 100 - 2E2, Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.Given her utility function,Wilma has an incentive to supply:

The moral-hazard problem occurs when:

A technique for dealing with the principal-agent problem is to:

Suppose that Wilma's utility function is given by U(E) = 100 - 2E2, Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.The marginal utility of effort for Wilma is:

Creditors and shareholders may have an incentive incompatibility because:

Incentive-compatible employment contracts exist when:

The savings and loan crisis of the early 1990s was caused by a moral-hazard problem because:

Principal-agent problems can exist between:

Optimal employment contracts for managers,given revenue risk and unobservable output,consist of:

Consider Mr.Ed,who purchases an insurance policy on a thoroughbred that he has acquired.He then proceeds to run the horse even though the horse has tendinitis.This is an example of:

Suppose that Wilma's utility function is given by U(E) = 100 - 2E², Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.If Wilma is forced to work an 8-hour day producing homemade dinners,her total utility will be:

Suppose that Wilma's utility function is given by U(E) = 100 - 2E², Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.Given her utility function,Wilma has an incentive to supply:

Suppose that Wilma's utility function is given by U(E) = 100 - 2E², Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.The marginal utility of effort for Wilma is: