2. A restaurant is either profitable (with profit of 810,000) or unprofitable (with zero profits) and the outcome of profits is observable . the owner of the restaurant. The owner hirres a manager to. the restaurant. The manager can choose high (H) or low effort (0) into running the restaurant. High effort costs more to the manager than low effort
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The restaurant’s S0CC844 in making 810,000 in profits depe.s on the manager. effort but is not completely determined by g So even if the manager puts in high effort it is possible for the restaurant to make zero profits and conversely positive profits can be real.. even 2 the manager puts in low effort However, the probability of making high prof (p) is higher when the manager pf in high effort than when he puts in low effort.
The following table describ.a the probability of success, p and effort costs, C for each type of effort
High Effort, H Low Effort, L 0.8 g4 8,00 $0
The manager is risk-neutral: • will accept a wage con.. as long as his expected surplus from the can.ct is greater than or equal to zero; and • rte high effort as long as his expected employee surplus from high effort is greater than or equal to the expected employee surplus from low effOrt.
Observable Effort
a) Suppose the owner could observe the managers effort corr.tly, des.be the wage con.ct that the owner would choose for the manager. b) What effort level v211.e manager choose under this wage contract, c) What is the restaurant owner’s expected profit, the managers expected surplus and the expected total surplus under this fixed wage contract, Fill in the .1814.
Expected Profit Expected Employee Surplus Expected Total Surplus
d) Is the outcome efficient?
Unobservable Effort
Now suppose the owner cannot observe effort. e) If the owner ..inued to offer the wage contract in part a), .at effort level would the manager choose’! W. are the expected prof to the restaurant with this wage con.ct’!
Suppose the wage contract was contingent on profits th. are realized afar the manager has exerted effort
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