Alisha905690
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Can someone please help me with this question

In a principal-agent interaction, say a firm owner and a worker – outline the basic
tenants of an optimal contract when the owner can perfectly observe/monitor
the worker’s effort.

Explain the market failure that emerges when the firm owner cannot
observe/monitor the worker’s effort. Propose a solution to this market failure.
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MindMax2000
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Whoever wrote this question is bias and seems to have the view workers are lazy and often slack off.

outline the basic tenants of an optimal contract when the owner can perfectly observe/monitor the worker’s effort
I am not sure what the person who wrote this question mean by tenants in this context. The only definition I know of involve occupancy of a building.
In terms of a situation where the owner can perflectly observe the worker, it means there is no asymmetric information. The principal and the agent has equal footing, and the agent doesn't get more than market rate. If the worker does anything the principal or owner doesn't like or voids the contract, the worker will get replaced.
Opinion: From the sounds of this, it seems the owner is kind of Draconian, doesn't trust workers, and would not budge in any way shape or form for the worker. Also is sounds like a terrible boss to work for (who wants a boss who constantly breathes down their neck, telling workers to work harder, cracking metaphorical whips, etc.).

Explain the market failure that emerges when the firm owner cannot observe/monitor the worker’s effort. Propose a solution to this market failure.
Due to asymmetry in information, the worker doesn't need to be as efficiently as he or she would need to. The owner may get less than he/she would otherwise get. Of course, if the worker does something that is less than standard, it might call a lot of things regarding quality into question.
Solutions due to asymmetric information usually involve regulations and transparency/disclosure e.g. references, examples of previous work. If the context of the question involves something else (as implied with the need for excessive CCTV footage or observing workers over the shoulder 24/7), then I would need to see the context of the question to comment further.
Opinion: whether you would categorise this as market failure is whether it's something you would consider a failure and whether it should be addressed. If owner is Draconian, then I think there should be better measures to control and observe the owner more than observing the worker.
Last edited by MindMax2000; 2 weeks ago
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Alisha905690
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(Original post by MindMax2000)
Whoever wrote this question is bias and seems to have the view workers are lazy and often slack off.

outline the basic tenants of an optimal contract when the owner can perfectly observe/monitor the worker’s effort
I am not sure what the person who wrote this question mean by tenants in this context. The only definition I know of involve occupancy of a building.
In terms of a situation where the owner can perflectly observe the worker, it means there is no asymmetric information. The principal and the agent has equal footing, and the agent doesn't get more than market rate. If the worker does anything the principal or owner doesn't like or voids the contract, the worker will get replaced.
Opinion: From the sounds of this, it seems the owner is kind of Draconian, doesn't trust workers, and would not budge in any way shape or form for the worker. Also is sounds like a terrible boss to work for (who wants a boss who constantly breathes down their neck, telling workers to work harder, cracking metaphorical whips, etc.).

Explain the market failure that emerges when the firm owner cannot observe/monitor the worker’s effort. Propose a solution to this market failure.
Due to asymmetry in information, the worker doesn't need to be as efficiently as he or she would need to. The owner may get less than he/she would otherwise get. Of course, if the worker does something that is less than standard, it might call a lot of things regarding quality into question.
Solutions due to asymmetric information usually involve regulations and transparency/disclosure e.g. references, examples of previous work. If the context of the question involves something else (as implied with the need for excessive CCTV footage or observing workers over the shoulder 24/7), then I would need to see the context of the question to comment further.
Opinion: whether you would categorise this as market failure is whether it's something you would consider a failure and whether it should be addressed. If owner is Draconian, then I think there should be better measures to control and observe the owner more than observing the worker.

Thank you! That helps a lot - You've explained it really clearly

Can I ask you two more questions please if you can help!

In a principal-agent interaction where the agent chooses her effort level, formulate and explain the optimisation problem for the principal. In your answer, be sure to outline the basic structure of the problem, and key concepts, e.g. participation constraint. (10marks)

Assume that the firm owner can observe the outcome variable (x), and offers a wage contract to the worker conditional on x. Under what condition does the worker refuses the contract?
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MindMax2000
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(Original post by Alisha905690)
In a principal-agent interaction where the agent chooses her effort level, formulate and explain the optimisation problem for the principal. In your answer, be sure to outline the basic structure of the problem, and key concepts, e.g. participation constraint. (10marks)

Assume that the firm owner can observe the outcome variable (x), and offers a wage contract to the worker conditional on x. Under what condition does the worker refuses the contract?
Unfortunately, I haven't studied optiomisation questions in this context. The optimisation questions I normally deal with involve linear programming.
Normally when it comes to economics, you're very likely going to require to formulate an equation that involves x^2, and you would need to differentiate the equation to set to 0.
You can involve natural logarithms in the equation, but I am not sure whether that's a bit advanced for what you are doing. If you are at university, then the use of ln should be appropriate, but you would also need to set a constraint where it resembles a line in the form ax+by = c i.e. negatively sloping down.
If there is more to the question, I might be able to give a bit more insight to how you can formulate this (doing it on the fly isn't exactly easy). It will also help if you let me know what level of maths you have been doing in your lessons, so I can gauge the level of maths needed.

In economics, the worker can refuse the contract for 2 main reasons:

  • He/she can look elsewhere and get a better deal (and from the sounds of it, he/she should)
  • The cost of the contract to the worker is more than the benefit the worker receives (under rational profit maximising assumption)
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