Question

1. Assume that you have inherited the family farm while mid-way through your undergraduate degree. The farm produces wheat. You want to complete your major in economics and want to employ a manager. The manager relies only on the income I you offer and she is assumed to maximise expected utility.

Her utility, at low effort: √I

Her utility, at high effort: √? − 46.3.

You are considering two compensation packages:

1. Pay a flat salary of $50,000.

1. Assuming a flat salary, calculate the manager’s utility associated with low effort and high effort. [5 marks]
2. Calculate the difference in terms of utility between high effort and low effort. Justify the difference. [5 marks]

Answer 1

i) Utility with low effort=√50,000=223.6

Utility with high effort=√50,000. -46.3=223.6-46.3=177.3

ii) difference between utility of low effort and high effort=223.6-177.3=46.3

As there is cost associated with manager effort ,if he doesn't effort or low effort,the the cost to him is zero

But if he does high effort that cost him 46.3 utiles.

But the salary is fixed in both high and low effort.

So utility he gets from low effort is high because low effort doesn't associated with any cost.