Instructor Manual For

Instructor Manual For Microeconomics 9 th Global Edition By Jeffrey Perloff

(All Chapters 1-20, 100% Original Verified, A+ Grade)

All Chapters Arranged Reverse:

20-1

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Chapter 20 Contracts and Moral Hazards  Chapter Outline

Challenge: Clawing Back Bonuses

20.1The Principal-Agent Problem Efficiency Symmetric Information Asymmetric Information Solved Problem 20.1

Application: Honest Cabbie?

20.2 Using Contracts to Reduce Moral Hazard Fixed-Fee Contracts Contingent Contracts State-Contingent Contracts

Application: Health Insurance and Moral Hazard

Solved Problem 20.2 Profit-Sharing Contracts Solved Problem 20.3

Application: Sing for Your Supper

Bonuses and Options Piece Rates Commissions Solved Problem 20.4 Choosing the Best Contract 20.3Monitoring to Reduce Moral Hazard Bonding Bonding to Prevent Shirking Trade-Off Between Bonds and Monitoring Solved Problem 20.5 Problems with Bonding

Application: Capping Oil and Gas Bankruptcies

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347  Perloff • Microeconomics, Ninth Edition, Global Edition Deferred Payments Efficiency Wages How Efficiency Wages Act like Bonds Efficiency Wages and Unemployment

Application: Wal-Mart’s Efficiency Wages

Monitoring Outcomes 20.4Checks on Principals

Application: Layoffs Versus Pay Cuts

20.5Contract Choice

Challenge Solution: Clawing Back Bonuses

ONLINE: Thinking Critically About a Current Event: Splitting Ill-Gotten Gains  Teaching Tips Chapter 20 continues the discussion started in Chapter 19 on transaction costs. Although it is not necessary to cover all of Chapter 19 before Chapter 20, it will be helpful if the class is familiar with at least the introductory portion of Chapter 19. Whereas Chapter 19 concentrated on informational asymmetries with respect to a participant’s true nature at the time of agreement, Chapter 20 focuses on how incentives influence behavior once a contract has been agreed upon.However, the material is not difficult and need not be saved for the end of the semester if you are interested in including it earlier. For example, one logical place to discuss principal-agent problems is while covering the factor markets (Chapter 15). By doing so, you can contrast labor markets at the aggregate level with labor contracts at the individual level.One of the keystones of the material in this chapter is incentive compatibility. You might suggest to the class that whenever they are evaluating an individual-level transaction, one of the prerequisites to sound analysis is to check the incentives of the buyer and the seller. The application on selfless or selfish doctors is a good way to motivate the discussion. This application should lead the students to think of experiences they’ve had or heard of in unnecessary dental work or medical tests. By beginning the discussion in this way, you should be able to lead the class directly to the importance of information and the opportunity for moral hazard problems to arise when information is asymmetric.The optimal contract type depends on the level of uncertainty and symmetry of information between buyer and seller. Possible arrangements include piece rates, fixed fees, hourly rates, and contingent fees. You might present the class with a number of transactions and ask them to decide what the best type of contract is. They may find that in many cases, the seller would prefer one type of contract and the buyer another, and a compromise between efficiency and risk bearing must be sought.Copyright © 2024 Pearson Education Ltd. All Rights Reserved. 3 / 4

Chapter 20 Contracts and Moral Hazards  348 The text includes an example of Amy and her employer, Paul, and the optimal employment contract.Another example is a professional athlete and a team owner. The athletes would like for the contract to be guaranteed, so that no matter what the performance level is, he or she receives payment. Employers (teams) would prefer to pay employees based on performance. The advantage of sports examples is that there is a steady stream of stories throughout the year of player negotiations that have reached stalemates over contract structure.An extreme example is professional baseball, in which top draft picks demand large contracts (typically in excess of $8 million) with a good portion guaranteed as a “signing bonus.” These demands come despite the fact that the drafted players have never played at the major league level. Because of the uncertainty involved (many top drafted players never succeed at the professional level in baseball), some teams have been very reluctant to meet players’ demands. In 2009, NBA rookie Ty Lawson was one of the first to agree to performance bonuses in his contract, making an additional 20% of his salary dependent on his performance. Previously that 20% was routinely given to the player regardless of performance.Another topic that can generate good class discussion is monitoring. Under some circumstances, employees don’t need to be monitored. If incentives are compatible, then the employees’ maximization problem is structured such that by maximizing their own utility, profits are maximized for the principal. In cases where this is not possible and shirking may occur, monitoring is required. An interesting topic to discuss here is the efficiency wage debate, as this provides a link to macroeconomics. Logic dictates that while at an individual level, efficiency wages should work, at a macroeconomic level, they should be inflationary. Especially in times of very low unemployment (such as 1996–2000), if firms are paying workers some level above the reservation wage, wage inflation should occur. Unfortunately, empirical confirmation of this effect is far from certain.In section 20.4, the focus moves from incentive compatibility for the agent to credibility of the principal.An example that students will likely be familiar with are rental bonds. In many places, these bonds are held by an independent authority to deal with any disputes at the end of a tenancy.Overall, this chapter should prove very interesting for students, whether they are preparing to enter the job market for the first time or have a great deal of experience. A good exercise might be to look at how contracts vary across professions and determine whether they vary due to informational asymmetries or incentive compatibility issues.Copyright © 2024 Pearson Education Ltd. All Rights Reserved.

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