Practice exam no.

2 - ECOS2201

1. An individual agent expects their payoff will be 200 with a probability of .4 and that their payoff
will be 60 the rest of the time. What is their expected payoff?

a. 65
b. 100
c. 80
d. 76
e. None of the above

2. Consider an agent with a expected utility function of U(x) = 5x, where x is the income received.
This individual is:
a. Risk neutral
b. Risk averse
c. Risk lover (risk seeker)
d. All of the above
e. None of the above.

3. Which statement is true?

a. The efficient allocation of risk is for the relatively risk-averse individual to bear more of the risk
b. The efficient allocation of risk requires that a risk averse person face no uncertainty and for
the risk neutral party to face all of the risk.
c. Given there are gains from trade to be realised, the relative risk-neutral individual should face less
of the uncertainty.
d. The requirements of the efficient allocation of risk suggests that it is never beneficial to make a
risk-averse individual, despite a potential principal agent problem (the agent takes a hidden action)
e. None of the above

4. Consider a principal-agent problem in which the principal wants the agent to take the lowest effort
possible and the agent is risk averse.

a. It is possible to get this level of effort, but it will require giving the agent some incentive contract
based on output.
b. The principal need only satisfy the incentive compatibility constraint, and need not worry about the
participation constraint.
c. This lowest effort level can be implemented without making the agent bearing any risk - there
is no conflict between efficient risk sharing and getting the desired level of effort.
d. All of the above
e. None of the above

5. Which statement is true?

a. A firm can increase the risk faced by a risk averse agent by improving the measurement of effort
b. It is not in the interests of the agent to have the principal to use a measurement device (signal) that
more closely measures their effort.
c. A principal can reduce the exogenous risk faced by an individual by improving their measurement
of agents effort, but the benefit is always smaller than the additional cost.
d. Improving the measurement of agents effort, while interesting, is not beneficial because outcomes
(profit, sales, etc) are what the principal cares about.
e. Improving the measurement signal of agents effort reduces the exogenous risk placed on
agents through the incentive contract, allowing the expected remuneration costs to be reduced.
f. All of the above
g. None of the above.
h. b and e
i. b and d.
j. g and f
k. a, b and c.

6. An efficiency wage:

a. Focuses on continuous monitoring and paying the worker an above market wage.
b. pays the worker a flat wage at the market rate, but involves the threat that the worker is fired if
found not putting in sufficient effort.
c. suggests that a worker will be paid a fixed salary plus a bonus based on output.
d. relies on occasional monitoring and an effective punishment if the agent is found to be
breaching the requirements in their contract
e. is not efficient.

7. Three key components of the multi-tasking problem are

a. risk sharing
b. potential substitution of effort across tasks
c. measurement error for the different tasks
d. all of the above
e. none of the above

8. In the multi-tasking problem

a. If one task has very powerful incentives for the agent, the incentives to undertake the other
task also need to be strong
b. If one task has very powerful incentives for the agent, the other task should be given weak
incentives
c. Overall effort is what is important with multi-tasking, not necessarily the split between tasks.
d. Incentives between tasks are substitutes for the principal.
e. None of the above

9. Consider two rivals facing each other in a market. Collusion (or cooperation) is facilitated by which
of the following factors:
a. repeated interaction
b. if the rivals sell a homogenous (or very similar product)

c. when prices of both firms are publically available.

d. More frequent interaction.
e. All of the above.

The following set-up applies for the next three questions.

Two firms produce in a market every period. There are an infinite number of periods (the firms live
forever). When deciding what to produce in a given period, the firms follow a trigger strategy: if both
firms have colluded in every previous period the firm will again produce the collusive output; if,
however, either firm cheated (did not collude) in any previous period the firm will produce the
punishment quantity. The per-period payoffs for each firm are 3 if both parties collude, 5 for a firm
that cheats on collusion and 1 in a punishment period. Each firm discounts future payoffs by a
discount factor per period, where 0<<1.

10. If both firms collude in every period, the present value of a firms entire payoff stream is:

(a)

3
1

(b)

5
1

(c)

3
1+

(d)

5
1+

11. The present value of the entire payoff stream for a firm that cheats in the first period is:

(a)

5
1

(b)

5
1+

(c) 5 +

1+

(d) 5 +

12. In order to sustain collusion forever in this market, the discount factor needs to be:

(a)

1
5

(b)

1
3

(c)

1
2

(d)

3
5

Short answer

1. A firm can be considered a way of balancing incentives and sharing risk when an agent needs to
undertake multiple tasks. Discuss.

2. Consider two rivals that meet in every period, for an infinite number of periods. Each firm adopts a
trigger strategy if either firm cheats on the cooperative agreement. Compare the following two cases:
(1) in the punishment phase (after cheating) each firm reverts to the Cournot equilibrium in every
subsequent period; and (2) in the punishment phase (after cheating) each firm reverts to the
homogenous products Bertrand equilibrium. In which case will cooperation be easier to sustain?
Explain your answer.

3. If a firm can perfectly monitor a workers effort, there is no agency problem. Discuss

4. Improved measurement of effort and increased agency costs are substitutes from firms
perspective. Discuss