Maximization and minimization under inequality constraints

1) Write the first order conditions of the following problem:

max ܽ ∙ ሺ‫ݕ ∙ ݔ‬ሻ௕
ሼ௫,௬ሽ
‫ݏ‬. ‫ݐ‬. 100 − m ∙ ‫ ݔ‬− ݊ ∙ ‫ ≥ ݕ‬0
‫≤ݔ‬4
‫≥ݕ‬0
2) Solve the following problem:
minሺ100 − ‫ݔ‬ሻ ∙ ‫ݕ‬
ሼ௫,௬ሽ
‫ݏ‬. ‫ݐ‬. ‫ ≥ ݕ ∙ ݔ‬10
‫≤ݔ‬2
‫≥ݕ‬0
Principal – agent problem
Company X produces a good x and it is characterized by a revenue function ܵሺ‫ݔ‬ሻ = 3 ∙ ‫ݔ‬. Company X delegates the
ଵ
production of x to firm Y. The cost function of firm Y is given by ‫ܥ‬ሺ‫ݔ‬ሻ = ߙ ∙ x ଶ; by probability ଶ ߙ = 0.1, otherwise
ଵ
ߙ = 0.3, (by probability ଶ ). Company X wants maximize his profits.
Consider the case of complete information
1. Write the problem of firm P and find the optimal set of contracts
Consider the case of incomplete information, at interim
2. Write the incentive compatibility constraints
3. Assume that firm P wants implements the quantities you find in point a. Write the optimal contracts.
4. Write the problem of firm P and find the optimal set of contracts.
5. Compute the optimal contracts in the case of shutdown of less efficient agent and prove if it is preferred to
the contracts you find in point d.
Consider the case of incomplete information, at the ex-ante stage
6. Finds the optimal quantities to implement
7. Write the participation constraint
8. Find the optimal set of contracts with lump-sum payment
Find the optimal set of contracts with lump-sum payment
Moral hazard
1) The revenue of a firm from the execution of a project is stochastic and can be either 100 or 50. The execution of
the project is delegated to an agent. The agent can exert either high effort or low effort. High effort cost M>0, low
effort cost 0. The firm cannot observe the effort of the agents but only the revenue of the project, then the firm will
pay to the agent a transfer ‫ݐ‬௟ when revenue is 50 and a transfer of ‫ݐ‬௛ when revenue is 100. Assume that the
probability to have the revenue equal to 100 is 0.6 if the agent exerts high effort, otherwise, if the agent exerts low
effort this probability is 0.4.
a) Assuming that agent utility function is ‫ݑ‬ሺ‫ݔ‬ሻ = ‫ݔ‬:
1) write the firm’s maximization problem to implement high effort,
2) compute the optimal contracts to implement high effort in the case of lump sum payment and
3) check if the principal prefers to do it.
b) Assuming that agent utility function is ‫ݑ‬ሺ‫ݔ‬ሻ = ‫ ݔ‬and ‫ݐ‬௛ ≥ 0, ‫ݐ‬௟ ≥ 0
4) compute the optimal contracts to implement high effort and
5) check if the principal prefers to do it.

2) A manufacturer supplies at marginal cost c=1 good x to the retailer. Demand can be either low (X = 10 – p) or high(
X = 20 – p). The probability of high demand is 0.8 if retailer exerts high effort; it is equal 0.2 if he exerts low effort.
High effort costs 1, low effort costs 0. Assuming the retailer’s utility function is ‫ݑ‬ሺ‫ݐ‬ሻ = 0.5 ∙ ‫ ݐ‬− 2, find the optimal
wholesale contracts.