Question 1

For the following, please answer "True" or "False" and explain why.
-In the presence of asymmetric information,production efficiency is assured when the principal and agent share the profit.

Accepted Answer

Since the agent faces full marginal cost but receives only a fraction of the marginal benefit,joint profit is not achieved.

Question 2

Jacko's rock band is putting out a new CD with its music label.The contract between the band and the label specifies that the band receive 25% of the gross revenues plus another $10,000 up front.The record label projects the demand for the album
p = 50 - 0.003Q
where p is the price per CD (in $)and Q is the number of CDs demanded.The cost (not including the band's salary)of producing the CD is constant at $5 per disc.
a.Compute the joint-profit-maximizing price and quantity.
b.Compute the profit maximizing price that the label will wish to set.
c.What price will Jacko want his band's CD sold for (assume he only cares about money earned from the CDs).

Accepted Answer

The answer of Jacko's rock band is putting out a...

Question 3

The market demand for MP3 players is p = 50 - 0.5Q,and the marginal cost for Nick to obtain and sell a MP3 player is $10.If he signed a fixed-fee rental contract with the store owner and pays $400 as the rent,
A) Nick will sell 20 MP3 players.
B) Nick will sell 30 MP3 players.
C) Nick will sell 40 MP3 players.
D) Nick will sell 50 MP3 players.

Accepted Answer

To find the profit-maximizing level of output, Nick needs to calculate his marginal revenue and set it equal to his marginal cost.

Nick's marginal revenue (MR) is the derivative of the market demand function:

MR = d(pQ)/dQ = p + Q(dp/dQ) = 50 - Q

Nick's profit is:

Profit = Total revenue - Total cost 
Profit = PQ - MCQ - Rent

where MC is the marginal cost and Rent is the fixed fee rental contract.

Substituting the market demand function for P, the marginal cost for MC, and the rental fee for Rent, we get:

Profit = (50Q - 0.5Q^2) - (10Q) - 400

Differentiating the profit function with respect to Q and setting it equal to zero to find the profit-maximizing level of output, we get:

d(Profit)/dQ = 50 - Q - 10 = 0

Solving for Q, we get:

Q = 40

Therefore, Nick will sell 40 MP3 players to maximize his profit.

Question 4

The market demand for MP3 player is p = 50 - 0.5Q,and the marginal cost for a MP3 player is $10.If Nick receives 60% of the total profit,then
A) Nick will produce 50 MP3 players.
B) Nick receives $500 as profit.
C) total profit is $800.
D) the efficiency in production is not achieved.

Accepted Answer

To maximize profit, we need to find the quantity where marginal revenue (MR) equals marginal cost (MC).
MR = 50 - Q
MC = 10

50 - Q = 10
Q = 40

So, the profit-maximizing quantity is 40.

Revenue: 
p*q = (50-0.5q)*q = 50q - 0.5q^2 
50*40 - 0.5*40^2 = $800

Total cost:
10*40 = $400

Total profit: 
$800 - $400 = $400

Nick receives 60% of the total profit, which is $240 ($400*0.6).

Therefore, the correct choice is C.

Question 5

In the presence of asymmetric information,a contingent contract
A) achieves production efficiency.
B) can lead to opportunistic behavior on the part of the agent.
C) is impossible to write.
D) will result in the principal earning all of the profit.

Accepted Answer

In the presence of asymmetric information, a contingent contract may lead to opportunistic behavior on the part of the agent. This occurs when the agent has private information that is relevant to the contract and uses it to their advantage, potentially to the disadvantage of the principal. This can result in a breakdown of trust and a failure of the contract, leading to lower efficiency.

Question 6

Sue offers to pay Al $50 for each painting of his that she sells in her gallery.Each painting sells for $75.The cost to Al of producing each painting is $55.Which of the following statements is true about this contract?
A) This contract is efficient.
B) This contract maximizes joint profit.
C) Al will not participate in this contract.
D) This is a fixed-fee contract.

Accepted Answer

The answer of Sue offers to pay Al $50 for...

Question 7

If information is asymmetric,explain why the hire contract is not efficient in production and a moral hazard exists,but the fixed fee to the principal contract is efficient and does not pose a moral hazard problem.

Accepted Answer

The answer of If information is asymmetric,explain why the hire...

Question 8

If the principal has full information,production efficiency without supervision can occur with
A) a fixed-fee rental contract.
B) a profit-sharing contract.
C) an incentive-compatible contract.
D) All of the above.

Accepted Answer

Production efficiency without supervision can occur with all the mentioned contracts if the principal has full information. A fixed fee rental contract can ensure efficiency by transferring operational decisions to the agent, who then has the incentive to be efficient to maximize their own profit. A profit-sharing contract aligns the interests of the principal and the agent by giving both parties a stake in the profitability of the venture, encouraging efficient production. An incentive-compatible contract is designed specifically to ensure that the agent's incentives are aligned with the principal's objectives, promoting efficiency even in the absence of supervision.

Question 9

Suppose two owners of a store agree to split the profit equally regardless of the number of hours each spends working at the store.As a result,
A) production efficiency is achieved.
B) each enjoys only half the marginal benefit of an additional hour working in the store.
C) one will work all of the time while the other works zero hours.
D) each will work as many hours as if he or she were the sole owner.

Accepted Answer

When profits are split equally regardless of the hours worked, each owner only receives half the benefit (or marginal benefit) of their additional work, as the other half goes to the co-owner. This can lead to a situation where both are less motivated to work additional hours since the full benefit of their labor is not realized individually.

Question 10

In the presence of asymmetric information,the only contract that results in production efficiency and no moral hazard is the one in which
A) the agent receives a fixed fee.
B) the principal receives a fixed rent.
C) profit is shared.
D) revenue is shared.

Accepted Answer

The answer of In the presence of asymmetric information,the only...

Question 11

The market demand for MP3 player is p = 50 - 0.5Q,and the marginal cost for Nick to obtain and sell a MP3 player is $10.If he signed a fixed-fee rental contract with the store owner and pays $1000 as the rent,
A) Nick will sell 20 MP3 players.
B) Nick will sell 40 MP3 players.
C) Nick will sell 50 MP3 players.
D) Nick will not sign the contract.

Accepted Answer

The answer of The market demand for MP3 player is...

Question 12

In the presence of asymmetric information,a hire contract
A) achieves production efficiency.
B) can lead to opportunistic behavior on the part of the agent.
C) is impossible to write.
D) will result in the principal earning all of the profit.

Accepted Answer

Asymmetric information occurs when one party has more information than the other party. In the case of a hire contract, the principal (employer) may not have complete information about the skills or intentions of the agent (employee). This can lead to the agent engaging in opportunistic behavior, such as shirking on the job or hiding relevant information. Therefore, choice B is the best answer. A is incorrect because production efficiency requires both parties to have complete information. C is incorrect because while it may be difficult to write a perfect contract with asymmetric information, it is not impossible. D is incorrect because the principal does not necessarily earn all of the profit in the presence of asymmetric information.

Question 13

The market demand for MP3 player is p = 50 - 0.5Q,and the marginal cost for Nick to obtain and sell a MP3 player is $10.If he receives $12 for each MP3 player he sells from the store owner and the store owner controls the quantity of MP3's available for sale,then
A) 40 MP3 players will be sold.
B) joint profit is $798.
C) joint profit will be maximized.
D) Nick will sell as many as he can.

Accepted Answer

The answer of The market demand for MP3 player is...

Question 14

Suppose a plaintiff hires a lawyer to represent her in a court case.The lawyer will be paid a fixed fee.Under this contract,
A) production efficiency is achieved.
B) the client bears all of the risk.
C) the lawyer has an incentive to lie about his hours worked.
D) All of the above.

Accepted Answer

The fixed fee arrangement means that the client bears all of the risk, as regardless of the outcome of the case, the lawyer will receive the same payment. This may incentivize the lawyer to spend less time on the case or to not put in as much effort. However, there is no mention of production efficiency or the lawyer lying about their hours worked in this scenario.

Question 15

Rents for stores at shopping malls are usually tied to the profits of the store.Comment on how this arrangement affects the mall owner's income versus a fixed rent.

Accepted Answer

The answer of Rents for stores at shopping malls are...

Question 16

In the presence of asymmetric information,a piece-rate contract
A) achieves production efficiency.
B) can lead to agents producing more output than would occur under a fixed-rent-paid-to-the-principal contract.
C) is impossible to write.
D) will result in the principal earning all of the profit.

Accepted Answer

In the presence of asymmetric information, a piece-rate contract incentivizes agents to produce more output as they are paid per unit produced. This can lead to agents producing more output than they would under a fixed-rent-paid-to-the-principal contract, which would result in a more efficient outcome for the principal. A is incorrect since production efficiency is not guaranteed under asymmetric information. C is incorrect as piece-rate contracts can be written even with information asymmetry. D is incorrect as the agent would still earn some profit based on their output.

Question 17

Suppose the principal offers to share a percentage of the profit with the agent.Such a contract
A) will yield the same income for the agent as a hire contract would.
B) is incentive compatible.
C) creates a production inefficiency.
D) would not be acceptable to any agent.

Accepted Answer

A profit-sharing contract provides an incentive for the agent to work harder and make more effort to generate profit for the principal, creating an incentive to increase effort that could potentially increase income beyond what a fixed wage would provide. Therefore, it is incentive compatible. However, it may create a production inefficiency if the agent's effort is not perfectly observable or if the profit-sharing contract is not properly designed. Option A is incorrect because the income can vary depending on the profit generated. Option D is incorrect because some agents may prefer a profit-sharing contract because it provides an incentive to increase effort and potentially earn higher income.

Question 18

The market demand for MP3 player is p = 50 - 0.5Q,and the marginal cost for Nick to obtain and sell a MP3 player is $12.If he receives 60% of the MP3 sales revenue,then
A) Nick will sell 38 MP3 players.
B) Nick will sell 50 MP3 players.
C) Nick will receive $270 as profit.
D) Total profit is $342.

Accepted Answer

The answer of The market demand for MP3 player is...

Question 19

For the following, please answer "True" or "False" and explain why.
-With full information,any contract will lead to production efficiency.

Accepted Answer

A hire or revenue sharing contract will not provide the incentives for the agent to maximize joint profit.

Question 20

Sam is suing someone in court for $10,000.The probability that Sam will lose the case is 1/h where h is the number of hours that Sam's attorney works on the case.The lawyer charges $500 per hour if he is to be paid hourly,or he requests 20% of the settlement if he is to be paid on a contingency basis.Assuming both Sam and the attorney are risk-neutral wealth maximizers,is either contract efficient?

Accepted Answer

The answer of Sam is suing someone in court for...

Quiz 19: Contracts and Moral Hazards

For the following, please answer "True" or "False" and explain why. -In the presence of asymmetric information,production efficiency is assured when the principal and agent share the profit.

The market demand for MP3 players is p = 50 - 0.5Q,and the marginal cost for Nick to obtain and sell a MP3 player is $10.If he signed a fixed-fee rental contract with the store owner and pays $400 as the rent,

The market demand for MP3 player is p = 50 - 0.5Q,and the marginal cost for a MP3 player is $10.If Nick receives 60% of the total profit,then

In the presence of asymmetric information,a contingent contract

Sue offers to pay Al $50 for each painting of his that she sells in her gallery.Each painting sells for $75.The cost to Al of producing each painting is $55.Which of the following statements is true about this contract?

If information is asymmetric,explain why the hire contract is not efficient in production and a moral hazard exists,but the fixed fee to the principal contract is efficient and does not pose a moral hazard problem.

If the principal has full information,production efficiency without supervision can occur with

Suppose two owners of a store agree to split the profit equally regardless of the number of hours each spends working at the store.As a result,

In the presence of asymmetric information,the only contract that results in production efficiency and no moral hazard is the one in which

The market demand for MP3 player is p = 50 - 0.5Q,and the marginal cost for Nick to obtain and sell a MP3 player is $10.If he signed a fixed-fee rental contract with the store owner and pays $1000 as the rent,

In the presence of asymmetric information,a hire contract

The market demand for MP3 player is p = 50 - 0.5Q,and the marginal cost for Nick to obtain and sell a MP3 player is $10.If he receives $12 for each MP3 player he sells from the store owner and the store owner controls the quantity of MP3's available for sale,then

Suppose a plaintiff hires a lawyer to represent her in a court case.The lawyer will be paid a fixed fee.Under this contract,

Rents for stores at shopping malls are usually tied to the profits of the store.Comment on how this arrangement affects the mall owner's income versus a fixed rent.

In the presence of asymmetric information,a piece-rate contract

Suppose the principal offers to share a percentage of the profit with the agent.Such a contract

The market demand for MP3 player is p = 50 - 0.5Q,and the marginal cost for Nick to obtain and sell a MP3 player is $12.If he receives 60% of the MP3 sales revenue,then

For the following, please answer "True" or "False" and explain why. -With full information,any contract will lead to production efficiency.