Question 1

Explain how more than one possible state of nature affects contract choices.

Accepted Answer

The uncertainty of the state of nature introduces the risk of random events.This forces principals and agents to incorporate efficiency of risk bearing into contracts.

Question 2

If the agent has more information than the principal and there is only one state of nature,then
A) efficiency in both production and risk-bearing can be achieved.
B) only efficiency in production can be achieved.
C) only efficiency in risk-bearing can be achieved.
D) neither efficiency in production nor efficiency in risk-bearing can be achieved.

Accepted Answer

A

Question 3

For the following, please answer "True" or "False" and explain why.
-The type of contract selected depends on the information available to the parties.

Accepted Answer

The efficiency in production and risk bearing from a specific contract will depend on the information available to the principal and agent.

Question 4

Production efficiency implies that
A) joint profits are maximized.
B) joint profits are minimized.
C) joint profits are zero.
D) joint profits can be increased.

Accepted Answer

Production efficiency occurs when an economy or a production process is operating in such a way that it cannot produce more of one good without producing less of another. This implies that resources are allocated in the most efficient manner, leading to the maximization of joint profits.

Question 5

In which of the following contracts is the agent's payment unaffected by his performance?
A) fixed-fee contract
B) hire contract
C) contingent contract
D) sharing contract

Accepted Answer

In a fixed-fee contract, the agent's payment is predetermined and not affected by his performance. The agent will receive the same compensation regardless of whether he meets or exceeds expectations.

Question 6

For the following, please answer "True" or "False" and explain why.
-Production inefficiency is more likely to occur when the principal has more information about work performance than the agent does.

Accepted Answer

It is when the agent has more information that production inefficiency is more likely to occur.The agent is able to shirk without being detected by the principal.

Question 7

Suppose an agent must pay the full marginal cost for an item but splits the marginal revenue with the principal.As a result,
A) joint profit is maximized.
B) joint profit is not maximized.
C) the agent will not enter into such a contract.
D) the agent wishes to sell as many items as he can.

Accepted Answer

If the agent is paying the full marginal cost, then splitting the marginal revenue will not provide enough incentive for the agent to sell more items. Therefore, joint profit will not be maximized. The agent may still enter into such a contract if there are no better alternatives, but it will not be the optimal choice for maximizing profit.

Question 8

Efficiency in risk bearing implies that
A) risk is completely eliminated.
B) the least risk-averse party bears most of the risk.
C) the most risk-averse party bears most of the risk.
D) all of the risk is borne by just one of the parties, regardless of the degree of risk aversion.

Accepted Answer

Efficiency in risk bearing means that the parties involved in a transaction share the risks in a way that reflects their levels of risk aversion. This means that the party that is least averse to risk should bear more risk than the party that is more risk-averse. This ensures that the risk is borne by the party that is best able to handle it, which leads to a more efficient allocation of resources. Option A is incorrect because complete elimination of risk is impossible. Option C is incorrect because it would lead to the less risk-averse party bearing too much risk, which would be inefficient. Option D is incorrect because it would result in one party taking on too much risk, which would not be efficient.

Question 9

In a store that sells souvenirs,suppose an agent receives a $1 commission for each unit sold,and the principal receives the residual profit.As a result,
A) joint profit is maximized.
B) the agent will sell until the principal's marginal cost equals $1.
C) no agent would enter into such a contract.
D) the agent wishes to sell as many units as he can.

Accepted Answer

The agent is motivated to sell as many units as possible because their commission is directly tied to the number of units sold, regardless of the cost or profit implications for the principal. This setup incentivizes the agent to maximize sales volume to increase their commission earnings.

Question 10

To reduce moral hazard,a firm may
A) pay workers at a piece rate.
B) offer a year-end bonus if firm profits are up.
C) offer stock options.
D) All of the above.

Accepted Answer

All of the options (paying workers at a piece rate, offering a year-end bonus if firm profits are up, and offering stock options) are strategies to align the interests of the employees with the goals of the firm, thereby reducing moral hazard.

Question 11

Describe the characteristics of an efficient contract between a principal and an agent.

Accepted Answer

The answer of Describe the characteristics of an efficient contract...

Question 12

Alex is hired as a sales agent and receives 10% commission on the sales price.The contract he signed is a
A) fixed-fee contract.
B) hire contract.
C) contingent contract.
D) sharing contract.

Accepted Answer

The answer of Alex is hired as a sales agent...

Question 13

When does it make sense to offer a worker a piece-rate contract?

Accepted Answer

The answer of When does it make sense to offer...

Question 14

The outcome of the state of nature affects the payoff to the agent under a
A) fixed-fee contract.
B) hire contract.
C) contingent contract.
D) All of the above.

Accepted Answer

The best choice is contingent contract because the outcome of the state of nature affects the payoff to the agent. A contingent contract is a contract in which the payment to the agent depends on the state of nature. Therefore, the agent will have an incentive to make choices that lead to a desirable outcome in order to maximize their payoff. Fixed-fee and hire contracts do not take into account the state of nature and do not provide incentives for the agent to make optimal choices.

Question 15

For the following, please answer "True" or "False" and explain why.
-When the production of a worker is relatively easily observable,the firm can pay a piece-rate.

Accepted Answer

A firm needs to measure the output of a worker to be able to pay him according to his production.When this is easy,piece-rates are more likely.

Question 16

The moral hazard associated with managers whose productivity is difficult to quantify can be decreased with
A) piece-rate contracts.
B) year-end bonuses.
C) decreased wages.
D) adverse selection.

Accepted Answer

The answer of The moral hazard associated with managers whose...

Question 17

Moral hazard occurs when contracts are written in such a way that
A) the interests of agent and principal converge.
B) the interests of agent and principal diverge.
C) agents will wish to maximize the principal's utility.
D) production and risk-bearing efficiency are achieved.

Accepted Answer

Moral hazard occurs when the interests of the agent (who is carrying out the actions on behalf of the principal) diverge from the interests of the principal. This can happen when the agent has limited liability or is insulated from the consequences of their actions, leading them to take excessive risks or not act in the best interest of the principal.

Question 18

Which of the following is NOT a difficulty with using a piece-rate contract?
A) measuring output
B) eliciting the desired behavior
C) gaining worker acceptance
D) workers taking too much time to achieve a certain task

Accepted Answer

Difficulty with workers taking too much time to achieve a certain task is not a concern with a piece-rate contract. The purpose of a piece-rate contract is to incentivize workers to increase their productivity to earn more money, so it would be expected that they complete tasks efficiently. However, measuring output, eliciting desired behavior, and gaining worker acceptance can all be challenges with implementing a piece-rate contract.

Question 19

Piece rates are practical when
A) individual output can be easily measured.
B) the quantity of the work is of much less importance than quality.
C) both employees and employers engage in opportunistic behavior.
D) All of the above.

Accepted Answer

Piece rates are most practical when individual output can be easily measured. This allows for accurate calculation of wages based on the quantity of work completed, and reduces the potential for disputes between employees and employers over how much work was actually done. Piece rates are generally less effective when it comes to measuring the quality of work, so situations where quality is more important than quantity may require a different method of compensation. Opportunistic behavior can be a concern with any type of compensation system, but piece rates may be less susceptible to this because they are highly transparent and linked to performance.

Question 20

Amy received her wage based on her working hours in the grocery store.The work contract she signed is an example of a
A) fixed-fee contract.
B) hire contract.
C) contingent contract.
D) sharing contract.

Accepted Answer

A hire contract is an agreement between an employee and an employer that specifies the terms and conditions of the employment, including the wage or salary to be paid. As Amy received her wage based on her working hours, it is a clear indication of a hire contract. A fixed-fee contract would specify a fixed amount to be paid regardless of the hours worked, a contingent contract would involve paying based on certain conditions being met, and a sharing contract would involve sharing profits or losses based on performance.

Quiz 19: Contracts and Moral Hazards

Explain how more than one possible state of nature affects contract choices.

If the agent has more information than the principal and there is only one state of nature,then

For the following, please answer "True" or "False" and explain why. -The type of contract selected depends on the information available to the parties.

Production efficiency implies that

In which of the following contracts is the agent's payment unaffected by his performance?

For the following, please answer "True" or "False" and explain why. -Production inefficiency is more likely to occur when the principal has more information about work performance than the agent does.

Suppose an agent must pay the full marginal cost for an item but splits the marginal revenue with the principal.As a result,

Efficiency in risk bearing implies that

In a store that sells souvenirs,suppose an agent receives a $1 commission for each unit sold,and the principal receives the residual profit.As a result,

To reduce moral hazard,a firm may

Describe the characteristics of an efficient contract between a principal and an agent.

Alex is hired as a sales agent and receives 10% commission on the sales price.The contract he signed is a

When does it make sense to offer a worker a piece-rate contract?

The outcome of the state of nature affects the payoff to the agent under a

For the following, please answer "True" or "False" and explain why. -When the production of a worker is relatively easily observable,the firm can pay a piece-rate.

The moral hazard associated with managers whose productivity is difficult to quantify can be decreased with

Moral hazard occurs when contracts are written in such a way that

Which of the following is NOT a difficulty with using a piece-rate contract?

Piece rates are practical when

Amy received her wage based on her working hours in the grocery store.The work contract she signed is an example of a