Incentives Flashcards
What are the 3 areas in which one party wants to prompt another party to complete a task
Market: Employers and workers etc
Government: Contractors, criminals etc
Social: Parent and child, couple
In the basic model, a … delegates a task to an …
In the basic model, a Principal delegates a task to an agent
The principal collects all the revenue or wider benefits – they are the …
The principal collects all the revenue or wider benefits – they are the residual claimant
Because the agent has some control of decisions, there is a separation of … from …
Because the agent has some control of decisions, there is a separation of ownership from control
What are some examples of incentive systems?
- Pay per hour
- Pay per unit of production
- Fixed payment contracts
- Revenue sharing
- Franchises
- Salaries and bonuses
For the effort of an agent, the principal receives all … …
For the effort of an agent, the principal receives all generated revenue
We assume that effort is fully … and …
We observe that effort is fully observable and verifiable
What is owner surplus? (and formula)
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
What is worker surplus? (and formula)
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.
What is a participation constraint?
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
What is an incentive compatibility constraint?
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.
What is the requirement for a worker to prefer taking a take it or leave it offer?
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.
How much surplus does the farmer need to give to the worker?
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.
What does the owner gain after giving effort inducing surplus to the worker?
After this, the owner is still the residual claimant, and receives all other generated surplus
What does an efficient contract mean?
A contract is efficient in the sense that it maximises social welfare
Why is farmer effort in a sharecropping agreement likely to be inefficiently low?
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
Why does a renting/franchising scheme elicit higher effort from the farmer?
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.
What is a franchise? (Use micro terminology)
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
Theory suggests that the effort workers exert should depend on their type of … …
Theory suggests that the effort workers exert should depend on the type of their payment contract
Theory suggests that the effort workers exert should depend on their type of … …
Theory suggests that the effort workers exert should depend on the type of their payment contract
If risk is transferred in a franchise deal, who is likely to buy the franchise?
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.
