Incentives

Question 1

What are the 3 areas in which one party wants to prompt another party to complete a task

Answer 1

Market: Employers and workers etc
Government: Contractors, criminals etc
Social: Parent and child, couple

Question 2

In the basic model, a … delegates a task to an …

Answer 2

In the basic model, a Principal delegates a task to an agent

Question 3

The principal collects all the revenue or wider benefits – they are the …

Answer 3

The principal collects all the revenue or wider benefits – they are the residual claimant

Question 4

Because the agent has some control of decisions, there is a separation of … from …

Answer 4

Because the agent has some control of decisions, there is a separation of ownership from control

Question 5

What are some examples of incentive systems?

Answer 5

• Pay per hour
• Pay per unit of production
• Fixed payment contracts
• Revenue sharing
• Franchises
• Salaries and bonuses

Question 6

For the effort of an agent, the principal receives all … …

Answer 6

For the effort of an agent, the principal receives all generated revenue

Question 7

We assume that effort is fully … and …

Answer 7

We observe that effort is fully observable and verifiable

Question 8

What is owner surplus? (and formula)

Answer 8

Owner surplus is the proportion of the total surplus the owner receives, and the formula is the total revenue minus the payment to the worker

Question 9

What is worker surplus? (and formula)

Answer 9

Worker surplus is the total proportion of the surplus the worker receives, and is given by the payment/incentive the worker receives, minus the cost of effort.

Question 10

What is a participation constraint?

Answer 10

A participation constraint is when the payment schedule causes the worker to prefer exerting a given level of effort, rather than taking their outside option

Question 11

What is an incentive compatibility constraint?

Answer 11

An incentive compatibility constraint is that the payment schedule must prompt the worker to prefer exerting x’ effort, rather than any other level of effort - x.

Question 12

What is the requirement for a worker to prefer taking a take it or leave it offer?

Answer 12

For a worker to take a take it or leave it offer, the payment minus the cost of effort must be higher than the payoff from the outside option.

Question 13

How much surplus does the farmer need to give to the worker?

Answer 13

The owner needs to give the farmer just enough surplus for the farmer to prefer effort x’ to the outside option, which gives the farmer U0.

Question 14

What does the owner gain after giving effort inducing surplus to the worker?

Answer 14

After this, the owner is still the residual claimant, and receives all other generated surplus

Question 15

What does an efficient contract mean?

Answer 15

A contract is efficient in the sense that it maximises social welfare

Question 16

Why is farmer effort in a sharecropping agreement likely to be inefficiently low?

Answer 16

A farmer in a sharecropping agreement is likely to be inefficiently low due to the fact that their pay is only based on a fraction of generated revenue, so they will choose a lower effort to maximise their welfare

Question 17

Why does a renting/franchising scheme elicit higher effort from the farmer?

Answer 17

A renting/franchising scheme elicits a higher payoff from the farmer because they gain a much higher proportion of the total revenue generated from their efforts, dependent on the franchise fee.

Question 18

What is a franchise? (Use micro terminology)

Answer 18

A franchise is a business structure in which a franchisee pays a fixed fee to purchase the full revenue rights and become the residual claimant of the business they set up

Question 19

Theory suggests that the effort workers exert should depend on their type of … …

Answer 19

Theory suggests that the effort workers exert should depend on the type of their payment contract

Question 20

Theory suggests that the effort workers exert should depend on their type of … …

Answer 20

Theory suggests that the effort workers exert should depend on the type of their payment contract

Question 21

If risk is transferred in a franchise deal, who is likely to buy the franchise?

Answer 21

If risk is transferred in a franchise deal, then people who are more risk averse are less likely to purchase the franchise, and those who are more risk neutral or risk averse are not.