13. Donald, who is risk-averse, works in an ice-cream shop. The owner of the sho

Question

13. Donald, who is risk-averse, works in an ice-cream shop. The owner of the shop, who is risk- neutral, cannot observe how hard Donald works. She pays Donald a fixed monthly salary plus a share of the revenues from the ice-cream sales. Assume that the contract is chosen optimally so as to maximize the owner's profit and that there are several similar ice-cream shops in the town that would like to hire Donald (i.e., the shops compete for his services). Now suppose the owner installs a camera in the shop, which allows her to monitor precisely the effort Donald provides every day and to base Donald's pay on the supplied level of effort. Which of the following is not true under this new pay scheme? A. Donald works harder than under the old pay scheme. B. Donald's income is higher than under the old pay scheme. C. Donald is exposed to less variation in his income than under the old pay scheme D. Donald's expected utility is lower than under the old contract. E. Total surplus from the employment relationship is higher than under the old pay scheme. 14. Eric produces hand carved wooden toys that he can sell for SX per toy. If Eric produces q toys on a given day, his total cost of effort for that day is given by Cla)-5q. Eric finds it optimal to produce 4 toys per day. What is the price at which Eric sells the toys? A. X= $25 B. X=$30 C. X $3 D. X = $40 5

Explanation / Answer

14. Eric maximises profit i.e. TR-TC

= Xq -5q^2

differentiate wrt q

X - 10q = 0

X = 10q

X = 10*4 = 40

Option D (X=$40)

Note: one complete question at a time

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