Inducing the worker to exert effort A worker can exert two effort levels, good or bad which induce a production error with probability 1/4 and 3/4 respectively. His utility function is: U(w,e)=100-10/w-c where w is the wage received and c takes the value of 2 if effort is good and 0 if effort is bad. Production errors are observable and so can be introduced into the worker’s contract but effort cannot. The product obtains is worth 20 if there are no errors and 0 otherwise. The principal is risk-neutral. Assume that the worker has reservation utility equal to u0=0
Calculate the optimal contract and the effort that the principal desires under conditions of symmetric information.
Calculate the optimal contract and the effort that the principal desires under conditions of asymmetric information.