Consider a risk neutral employer and a risk neutral employee. The employee can either work hard or not. Let L for low effort or H for high effort correspond to its effort level. If the employee exercises low efforts, then it has an associated cost of 3 to him.But he generates profits for the employer of 8 with propability .5 and 0 with probability of .5 . If the employee exercises low efforts, then it has an associated cost of 4 to him. But he generates profits for the employer of 8 with probability .75 and 0 with probability .25 . Assume that the employee maximizes his pay minus his costs and it has an outside opportunity of 0 (no effort no rewards). If the employer can only offer a take or leave it offer before observing the effort level:
1. Set up the problem the employer faces
2. Set up the problem the employee faces
3. Can the employer offer a wage to induce high efforts?
4. If the employee is willing to wait after the employer sees the outcome to get paid (i.e a bonus scheme) would your answer change? If so, how?
5. If the employer can observe the effort level before he pays his employee, what should he do?