Consider the salary of Mary Sue Nelson,a sales agent for Plain Truth Advertising.She has an effort cost of C = e² and a reservation wage of $1,500 so that wage package is W = 1,500 + 0.2 Q where the CEO sets the incentive at 0.2 and Q = 200 e.If the CEO increases the incentive from 0.2 to 0.25,what happens to Nelson's effort? Will profits rise or fall?

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The Answer is Under the 0.2 incentive,Mary Sue's expected benefits are 1,500 + 0.2Q = 1,500 + 0.2(200e)= 1,500 + 40e.Her marginal expected benefit from another hour of effort is therefore 40.Her marginal cost from effort is 2e.Therefore her optimal effort is 40 = 2e or effort is 20 hours.,She will earn E(W)= 1500 + 0.2(200(20))= $2,300.Her output is E(Q)= 200(20)= $4,000 in sales revenue.Expected profit for the company is E(Q - W)= 4,000 - 2,300 = $1,700.Solving the problem under the higher incentive of 0.25,her marginal expected benefit is 0.25(200)= 50 and her optimal effort satisfies 50 = 2e or e = 25.Therefore,her effort increases.Expected output increases to Q = 200(25)= $5,000.Expected wages are 1,500 + 0.25(200(25))= $2,750.Expected profit will rise,in this case,to $2,250.

Consider the Salary of Mary Sue Nelson,a Sales Agent for Plain