Suppose a new contracting environment with an economic environment that looks more uncertain is considered.This new contract will result in:
A) an increase in the marginal cost and a longer optimal contract.
B) an increase in the marginal cost and a shorter optimal contract.
C) a decrease in the marginal cost and a longer optimal contract.
D) a decrease in the marginal cost and a shorter optimal contract.

Question

Quizplus · Accepted Answer

An increase in economic uncertainty typically leads to an increase in the risk of the project and hence an increase in the marginal cost of the contract. As a result, the optimal contract length will be shorter as it would be more beneficial for the parties to react to any changes in the uncertain economic environment.

Suppose a New Contracting Environment with an Economic Environment That