This homework is on the simplest possible version of the principal-agent model. It is this model that produces pay for performance as a feature. It is important to understand this base model before we delve into various realistic ways of complicating the model. (Mostly we will talk about that but I might do some additional modeling in class after going over the basic model.) There is a video I'd like you to watch first. It should give you the background you need to do the homework.

Video

I can't figure out the answer for cells G94 and 96 about indifference curves. So far I've tried =(C82*G59)+((1-C82)*E60)-C84 and a similar variation.

ReplyDeleteIt's a little early for me to respond on algebra, so let's try to talk conceptually and ask whether you are doing the right manipulations.

ReplyDeleteFor the first one, where there is certainty, and let's say the certainty payment is w, then the equation is

u(w) = ubar.

You then need to invert that.

w = u-1(ubar).

The second one is similar. I will let you work through the algebra.

I am stuck on this same one. I am not quite sure I understand what equation I am supposed to use first to find the certainty point I am plugging in similar equations to what Joan has described

ReplyDeleteDid you read through my little explanation above? This part is really just like the homework on risk preference.

Deletemaybe I am just confused because that homeworks variables are slightly different. Does p(0)= x1 and p(e)=x2 from the risk preference homework?

DeleteNo - now consider the homework with adverse selection. There were good risks and bad risks. Low output here is is like suffering a loss. High output is like not having a loss. p(0), is the probability of low output when low effort is taken. That is like being a bad risk, except in the adverse selection homework, being a bad risk was a property of the individual. Here, low effort is a choice the agent might make. p(e) is the probability of low output when high effort is taken. It is like being a good risk. So taking high effort makes low output less likely, but it is still possible. In other words, just because you bust a gut, there is no guarantee that you will get good results. But it is more likely you that you will get good results.

DeleteDoes that help?

I got G94 I am now having trouble with b96. I raised wL=5000^ c85 (alpha) to get 9.739 which is in box m87 on my sheet.... then I am typing in (c86^-1)*[((m94)-(c82*m87))/(1-c82)] and I am not getting the answer. Can you please elaborate where I may be going wrong

DeleteI'm not going to comment on the Excel formulas, that's for you to work through. But that is the equation you want to begin with. Have you done this?

ReplyDeletep(0)u(5000) + [1 - p(0)]u(wH) = uBar.

You need to manipulate that to solve for wH.

Thank you I deduced the answer from that equation, not quite sure why I couldnt find that one myself

DeleteThere was a video you were supposed to watch. If you haven't done that yet, I'd encourage it.

DeleteIm having a hard time finding what the value of "u" is for the answer in cell B96. I've tried tons of different values and watched the video multiple times but can't seem to get the right answer

ReplyDeleteFor starters - the questions is asking for wH, the payment to the agent in the high output state. It is not asking for u. Look at the equation I wrote in response to Ben Bernanke.

Delete