Microeconomics with Calculus, 2e, International Edition (Perloff) Chapter 19 Contract Theory 19.

1 Principal-Agent Problem 1) In which of the following contracts is the agent's payment unaffected by his performance? A) fixed-fee contract B) hire contract C) contingent contract D) sharing contract Answer: A Topic: Principal-Agent Problem 2) The outcome of the state of nature affects the payoff to the agent under a A) fixed-fee contract. B) hire contract. C) contingent contract. D) All of the above. Answer: C Topic: Principal-Agent Problem 3) Moral hazard occurs when contracts are written in such a way that A) the interests of agent and principal converge. B) the interests of agent and principal diverge. C) agents will wish to maximize the principal's utility. D) production and risk-bearing efficiency are achieved. Answer: B Topic: Principal-Agent Problem 4) Efficiency in risk bearing implies that A) risk is completely eliminated. B) the least risk-averse party bears most of the risk. C) the most risk-averse party bears most of the risk. D) all of the risk is borne by just one of the parties regardless of the degree of risk aversion. Answer: B Topic: Principal-Agent Problem 5) Production efficiency implies that A) joint profits are maximized. B) joint profits are minimized. C) joint profits are zero. D) joint profits can be increased. Answer: A Topic: Principal-Agent Problem

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For the following, please answer "True" or "False" and explain why. 6) Production inefficiency is more likely to occur when the principal has more information about work performance than the agent does. Answer: False. It is when the agent has more information that production inefficiency is more likely to occur. The agent is able to shirk without being detected by the principal. Topic: Principal-Agent Problem 7) The type of contract selected depends on the information available to the parties. Answer: True. The efficiency in production and risk bearing from a specific contract will depend on the information available to the principal and agent. Topic: Principal-Agent Problem 8) Describe the characteristics of an efficient contract between a principal and an agent. Answer: An efficient contract is efficient in production. The principal's and agent's combined value of the contract is maximized. An efficient contract is also efficient in risk bearing. The risk sharing is optimal so that a relatively less risk-averse person bears more of the risk. Topic: Principal-Agent Problem 9) Explain how more than one possible state of nature affects contract choices. Answer: The uncertainty of the state of nature introduces the risk of random events. This forces principals and agents to incorporate efficiency of risk bearing into contracts. Topic: Principal-Agent Problem 19.2 Production Efficiency 1) Suppose an agent must pay the full marginal cost for an item but splits the marginal revenue with the principal. As a result, A) joint profit is maximized. B) joint profit is not maximized. C) the agent will not enter into such a contract. D) the agent wishes to sell as many items as he can. Answer: B Topic: Production Efficiency 2) In a store that sells souvenirs, suppose an agent receives a $1 commission for each unit sold, and the principal receives the residual profit. As a result, A) joint profit is maximized. B) the agent will sell until the principal's marginal cost equals $1. C) no agent would enter into such a contract. D) the agent wishes to sell as many units as he can. Answer: D Topic: Production Efficiency

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3) Suppose the principal offers to share a percentage of the profit with the agent. Such a contract A) will yield the same income for the agent as a hire contract would. B) is incentive compatible. C) creates a production inefficiency. D) would not be acceptable to any agent. Answer: B Topic: Production Efficiency 4) If the principal has full information, production efficiency without supervision can occur with A) a fixed-fee rental contract. B) a profit-sharing contract. C) an incentive-compatible contract. D) All of the above. Answer: D Topic: Production Efficiency 5) Suppose two owners of a store agree to split the profit equally regardless of the number of hours each spends working at the store. As a result, A) production efficiency is achieved. B) each enjoys only half the marginal benefit of an additional hour working in the store. C) one will work all of the time while the other works zero hours. D) each will work as many hours as if he or she were the sole owner. Answer: B Topic: Production Efficiency 6) Sue offers to pay Al $50 for each painting of his that she sells in her gallery. Each painting sells for $75. The cost to Al of producing each painting is $55. Which of the following statements is true about this contract? A) This contract is efficient. B) This contract maximizes joint profit. C) Al will not participate in this contract. D) This is a fixed-fee contract. Answer: C Topic: Production Efficiency 7) In the presence of asymmetric information, the only contract that results in production efficiency and no moral hazard is the one in which A) the agent receives a fixed fee. B) the principal receives a fixed rent. C) profit is shared. D) revenue is shared. Answer: B Topic: Production Efficiency

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8) In the presence of asymmetric information, a contingent contract A) achieves production efficiency. B) can lead to opportunistic behavior on the part of the agent. C) is impossible to write. D) will result in the principal earning all of the profit. Answer: B Topic: Production Efficiency 9) In the presence of asymmetric information, a hire contract A) achieves production efficiency. B) can lead to opportunistic behavior on the part of the agent. C) is impossible to write. D) will result in the principal earning all of the profit. Answer: B Topic: Production Efficiency 10) In the presence of asymmetric information, a piece-rate contract A) achieves production efficiency. B) can lead to agents producing more output than would occur under a fixed-rent-paid-to-the-principal contract. C) is impossible to write. D) will result in the principal earning all of the profit. Answer: B Topic: Production Efficiency For the following, please answer "True" or "False" and explain why. 11) In the presence of asymmetric information, production efficiency is assured when the principal and agent share the profit. Answer: False. Since the agent faces full marginal cost but receives only a fraction of the marginal benefit, joint profit is not achieved. Topic: Production Efficiency 12) With full information any contract will lead to production efficiency. Answer: False. A hire or revenue sharing contract will not provide the incentives for the agent to maximize joint profit. Topic: Production Efficiency

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13) Sam is suing someone in court for $10,000. The probability that Sam will lose the case is 1/h where h is the number of hours that Sam's attorney works on the case. The lawyer charges $500 per hour if he is to be paid hourly, or he requests 20% of the settlement if he is to be paid on a contingency basis. Assuming both Sam and the attorney are risk-neutral wealth maximizers, is either contract efficient? Answer: First determine the expected value of the settlement as a function of the hours worked. E(X) = 10,000 (1 - (1/h)).

At the hourly rate, Sam wants the attorney to work 5 hours since the gain in expected benefit equals the cost of that hour. The attorney's income is 500 h. He wishes to bill (hopefully work) as many hours as possible. This can (will) exceed 5. Under the contingency arrangement, Sam does not incur a per hour marginal cost. He wants the attorney to work on the case until the expected marginal cost is zero; that is, h goes to infinity. The attorney incurs a $500 opportunity cost for each hour spent on the case but enjoys only 20% of the marginal expected benefit. Thus a third hour on the case is worth only $340 (1700/5) to the attorney. He'll stop after two hours. Thus both plans are inefficient in production. One plan has the attorney billing too many hours, the other has the attorney working not enough. Topic: Production Efficiency 14) Rents for stores at shopping malls are usually tied to the profits of the store. Comment on how this arrangement affects the mall owner's income versus a fixed rent. Answer: It is likely that such an arrangement reduces the mall owner's income. When paying a fixed rent, the store operates efficiently. When having to share the profit with the mall owner, the store owner has a reduced marginal benefit without a reduction in her marginal cost. Additionally, when having to share the profit, the store owner has the incentive to lie about the store's profit. From the mall owner's perspective, a profit-sharing contract gives her the incentive to make expenditures (maintenance) that increase the number of mall customers and, possibly, the store's profit. Topic: Production Efficiency 15) If information is asymmetric, explain why the hire contract is not efficient in production and a moral hazard exists, but the fixed fee to the principal contract is efficient and does not pose a moral hazard problem. Answer: With the hire contract, the agent has no incentive to behave in such a manner as to maximize the joint profit of the agent and the principal. The contract provides no incentive for the agent to behave optimally, and the contract does nothing to prevent moral hazard. The agent can usually increase his value of the contract by committing a moral hazard. The fixed fee to the principal contract gives the agent all the profit after the fee to the principal is paid. This provides an incentive for the agent to behave optimally and maximize the profit of the firm. The agent's desire to behave optimally prevents moral hazard. Topic: Production Efficiency

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16) Jacko's rock band is putting out a new CD with its music label. The contract between the band and the label specifies that the band receive 25% of the gross revenues plus another $10,000 up front. The record label projects the demand for the album p = 50 - 0.003Q where p is the price per CD (in $) and Q is the number of CDs demanded. The cost (not including the band's salary) of producing the CD is constant at $5 per disc. a. Compute the joint-profit-maximizing price and quantity. b. Compute the profit maximizing price that the label will wish to set. c. What price will Jacko want his band's CD sold for (assume he only cares about money earned from the CDs). Answer: a. The joint profit function is: = (50-0.003Q)Q -5Q The optimum is where d/dQ=0, or: 50 - 0.006Q -5 = 0 Q=7500, p = 27.5 b. The label's net profits are: =.75(50 - 0.003Q)Q - 5Q The first order condition is: 37.5 - .0045Q - 5 = 0 Solving Q=7222, p=28.33 c. Jeremy's income is: = .25(50-0.003Q)Q + 10,000 The 10,000 does not influence the optimal price and quantity for Jacko, which occurs where: 12.5 - 0.0015Q = 0 or Q = 8,333 and p=25. Topic: Production Efficiency 19.3 Trade-Off Between Efficiency in Production and Risk Bearing 1) Suppose a plaintiff hires a lawyer to represent her in a court case. The lawyer will be paid a fixed fee. Under this contract A) production efficiency is achieved. B) the client bears all of the risk. C) the lawyer has an incentive to lie about his hours worked. D) All of the above. Answer: B Topic: Trade-off Between Efficiency in Production and Risk Bearing 2) Suppose a plaintiff hires a lawyer to represent her in a court case. The lawyer will be paid by the hour. Under this contract A) production efficiency is not achieved. B) the client bears all of the risk. C) the lawyer has an incentive to lie about his hours worked. D) All of the above. Answer: D Topic: Trade-off Between Efficiency in Production and Risk Bearing
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3) In the presence of asymmetric information, A) all contracts are efficient. B) efficiency in risk bearing cannot be achieved. C) a trade-off exists between risk-bearing efficiency and production efficiency. D) no contracting will take place. Answer: C Topic: Trade-off Between Efficiency in Production and Risk Bearing 4) Suppose a plaintiff hires a lawyer to represent her in a court case. The lawyer will receive a share of the settlement if the plaintiff wins. Under this contract A) production efficiency cannot be achieved. B) the client bears all of the risk. C) the lawyer bears all of the risk. D) the risk is shared. Answer: D Topic: Trade-off Between Efficiency in Production and Risk Bearing 5) Suppose a plaintiff hires a lawyer to represent her in a court case. She agrees to pay the lawyer a wage per hour. She knows precisely what the lawyer should do and how long each activity should take, and she can verify that the lawyer has correctly completed each activity. She can terminate the contract at any time. With this contract A) the lawyer bears all the risk. B) the risk is shared by the lawyer and the plaintiff. C) production efficiency can be achieved. D) production efficiency is impossible. Answer: C Topic: Trade-off Between Efficiency in Production and Risk Bearing 6) Suppose a plaintiff hires a lawyer to represent her in a court case. Under which of the following contracts is production efficiency assured? A) The lawyer is paid by the hour. B) The lawyer receives a share of the settlement. C) The lawyer receives a fixed fee. D) The lawyer pays the client a fee for the right to the entire settlement. Answer: D Topic: Trade-off Between Efficiency in Production and Risk Bearing 7) Suppose a plaintiff hires a lawyer to represent her in a court case. To which of the following contracts would a highly risk-averse plaintiff agree? A) The lawyer is paid by the hour. B) The lawyer receives a share of the settlement. C) The lawyer receives a fixed fee. D) The lawyer pays the client a fee for the right to the entire settlement. Answer: D Topic: Trade-off Between Efficiency in Production and Risk Bearing

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8) Under which one of the following conditions would a lawyer accept a case on a contingent basis? A) The lawyer is risk averse. B) The client is risk loving. C) The lawyer has several cases on a contingent basis with payoffs that are not perfectly positively correlated. D) The lawyer is more risk averse than the client is. Answer: C Topic: Trade-off Between Efficiency in Production and Risk Bearing 9) Under which one of the following contracts does an agent have the least incentive to behave opportunistically? A) The agent pays a fixed fee to the principal for the right to all future payoffs. B) The agent works for the principal on an hourly basis. C) The agent receives a share of the profit. D) The agent works for the principal on a per unit basis. Answer: A Topic: Trade-off Between Efficiency in Production and Risk Bearing 10) Suppose a plaintiff hires a lawyer to represent her in a court case. Under which of the following contracts is efficiency in risk bearing assured? A) The lawyer is paid by the hour. B) The lawyer receives a share of the settlement. C) The lawyer receives a fixed fee. D) It is impossible to determine without the degree of risk aversion for each. Answer: D Topic: Trade-off Between Efficiency in Production and Risk Bearing 11) One reason that lawyers might prefer a contingent contract when representing a plaintiff in a tort case is that A) lawyers are risk neutral. B) diversification of many cases allows lawyers to reduce risk. C) lawyers are typically confident about winning every case. D) hourly rates for lawyers are usually very low. Answer: B Topic: Trade-off Between Efficiency in Production and Risk Bearing 12) A contingent contract can create production inefficiency; however, many principals accept this because A) inefficiency is inevitable. B) monitoring is costless. C) risk is reduced. D) profit will increase as a result. Answer: C Topic: Trade-off Between Efficiency in Production and Risk Bearing

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13) If an agent is risk neutral and a principal is risk averse, which of the following contracts would be efficient in risk bearing? A) A fixed fee is paid to the agent. B) A fixed fee is paid to the principal. C) An hourly rate is paid to the agent. D) The agent enjoys a share of the profit. Answer: B Topic: Trade-off Between Efficiency in Production and Risk Bearing For the following, please answer "True" or "False" and explain why. 14) In the presence of asymmetric information with costless monitoring and enforcement, a hire contract results in production efficiency. Answer: True. The agent has the incentive to shirk; however, since she can be monitored costlessly, she will not. Topic: Trade-off Between Efficiency in Production and Risk Bearing 15) Sam hires an attorney to present a court case. If Sam wins the case, he will receive some money. This payoff is a function of the attorney's hours and which judge is assigned the case that day. Judge A is very understanding toward people in Sam's position, but judge B is very harsh toward people like Sam. Is it possible for Sam to get the attorney to deliver the optimal amount of effort and make the attorney bear all of the risk? Answer: Yes. If Sam accepts a fixed payment from the attorney and lets the attorney keep the proceeds, if any, from the case, the attorney bears all of the risk. Since the attorney will enjoy the full marginal benefit of her effort, she puts in the optimal level of effort. Topic: Trade-off Between Efficiency in Production and Risk Bearing 16) Sarah's demand for routine medical visits is q = 10 - 0.2p when she is healthy and q = 20 - 0.2p when she is sick. Medical visits cost $50 each if Sarah has no medical insurance. She is sick 20% of the time. Sarah is considering two different insurance plans. One offers free medical visits; the other plan costs less up front but requires that Sarah pay $5 per medical visit. Compare the two plans in terms of the trade-off between risk and moral hazard. Answer: At $50 per visit, Sarah makes no visits when she is healthy and 10 visits when she is sick. Under the first plan, she makes 10 visits when she is healthy and 20 visits when she is sick. Thus Sarah will make 10 more visits with the first insurance plan. Under the second plan, Sarah makes nine visits when she is healthy and 19 visits when she is sick. The moral hazard is greater (by one visit) under the first plan. Under the first plan, Sarah's risk is zero. She pays only the up-front premium regardless of her health. Under the second plan she will make (0.8 9) + (0.2 19) = 11 visits at $5 each. Her risk, as measured by the variance of her expenditures, is (0.8 100) + (0.2 1600) = 400. Thus the second plan is riskier for her but generates less of a moral hazard on her part. Topic: Trade-off Between Efficiency in Production and Risk Bearing

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19.4 Payments Linked to Production or Profit 1) To reduce moral hazard, a firm may A) pay workers at a piece rate. B) offer a year-end bonus if firm profits are up. C) offer stock options. D) All of the above. Answer: D Topic: Payments Linked to Production or Profit 2) Piece rates are practical when A) individual output can be easily measured. B) the quantity of the work is of much less importance than quality. C) both employees and employers engage in opportunistic behavior. D) All of the above. Answer: A Topic: Payments Linked to Production or Profit 3) Which of the following is not a difficulty with using a piece-rate contract? A) measuring output B) eliciting the desired behavior C) gaining worker acceptance D) workers taking too much time to achieve a certain task Answer: D Topic: Payments Linked to Production or Profit 4) The moral hazard associated with managers whose productivity is difficult to quantify can be decreased with A) piece-rate contracts. B) year-end bonuses. C) decreased wages. D) adverse selection. Answer: B Topic: Payments Linked to Production or Profit For the following, please answer "True" or "False" and explain why. 5) When the production of a worker is relatively easily observable the firm can pay a piece-rate. Answer: True. A firm needs to measure the output of a worker to be able to pay him according to his production. When this is easy, piece-rates are more likely. Topic: Payments Linked to Production or Profit

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6) When does it make sense to offer a worker a piece-rate contract? Answer: Piece-rate contracts require that a worker's output can be measured, that the right behavior is elicited, and that workers can be persuaded to accept the contract. Workers like teachers or managers, whose output is difficult to measure, are not good candidates for piece rates. When quality is more important than quantity, such as with medical care, piece-rate contracts are not good. In terms of eliciting the right behavior, workers who are poorly monitored can overstate the work done or needed. Finally, workers may not accept the contract out of fear that their incomes may eventually fall. Topic: Payments Linked to Production or Profit 19.5 Monitoring 1) If a firm has established monitoring devices that have a 50% chance of detecting shirking, and an employee gains $5,000 from shirking, the employer can deter shirking by having employees post a bond equal to A) $2,500. B) $5,000. C) $10,000. D) $50,000. Answer: C Topic: Monitoring 2) Monitoring is often used by firms in an attempt to decrease A) shirking. B) piece rates. C) adverse selection. D) signaling. Answer: A Topic: Monitoring 3) As the probability of detecting shirking increases, the size of the bond necessary to deter shirking A) also increases. B) stays the same. C) decreases. D) increases at an exponential rate. Answer: C Topic: Monitoring 4) Which of the following workers is most likely to be asked to post a bond? A) construction contractor B) fast food worker C) sanitation worker D) book author Answer: A Topic: Monitoring

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5) Which of the following would not be used by firms to deter shirking? A) requiring employees to post a bond B) offering a bonus after five years of service C) paying more than the market wage D) paying less than the market wage Answer: D Topic: Monitoring 6) The benefit to employers of deferred-payments is that A) adverse selection is eliminated. B) employers cannot engage in any opportunistic behavior. C) these payments raise the cost of being fired, so more monitoring is needed. D) these payments raise the cost of being fired, so less monitoring is needed. Answer: D Topic: Monitoring 7) An efficiency-wage premium serves the same function as a bond because, just as with a bond, the premium represents A) the amount the employee loses if caught shirking. B) the expected value of the amount the employee loses if he shirks. C) the cost of monitoring the employee. D) the gain to the employee if he shirks. Answer: A Topic: Monitoring 8) A profit-maximizing firm that uses an efficiency wage and monitors will increase the wage it pays its workers until A) the worker requires no monitoring. B) the worker receives the market wage and requires full-time monitoring. C) the cost of monitoring the worker equals the efficiency wage. D) the change in the workers' productivity from being monitored times the per time unit cost of monitoring equals one. Answer: D Topic: Monitoring 9) If an additional dollar spent on monitoring would reduce shirking by 10 minutes, then the firm will increase the worker's wage by $1 if this caused A) shirking to increase by less than 10 minutes. B) shirking to decrease by more than 10 minutes. C) shirking to decrease by less than 10 minutes. D) monitoring to become unnecessary. Answer: B Topic: Monitoring

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10) If all firms pay an efficiency wage, then A) there is no cost to shirking because the shirking worker can receive his high wage at another firm after being caught and fired. B) the macroeconomy would enjoy a prolonged period of near-zero unemployment. C) there is a cost to shirking because the efficiency wage is less than it would have been if only a few firms paid it. D) there is a cost to shirking because the shirking worker will spend a greater time unemployed after being caught and fired. Answer: D Topic: Monitoring For the following, please answer "True" or "False" and explain why. 11) When shirking at the workplace occurs, increased monitoring of workers is the only effective way to reduce this behavior. Answer: False. There are other means of reducing shirking, such as an efficiency wage, bonding workers, or screening applicants. Topic: Monitoring 12) Explain why a firm may hire managers to operate outlets near the firm's headquarters, but may sell franchise rights for the outlets located greater distances from the headquarters. (With a franchise, the firm sells a brand name and a method of doing business to someone who then owns and operates the outlet.) Answer: To avoid moral hazard problems, the firm must monitor the managers of the outlets. The firm can cost-effectively monitor operations near the headquarters. However, the cost of monitoring rises the farther away the outlet is located. Thus the firm may earn more profit by franchising the outlets located far from the headquarters instead of trying to monitor them. Topic: Monitoring 13) Suppose the probability of an employee being caught shirking, q, is a function of the employer's monitoring, M, such that q = M/100. If workers must put up a $1,000 bond and the gain to each worker from shirking is $100, what is the employer's optimal level of monitoring that is just sufficient to discourage shirking? Answer: Workers are deterred from shirking if q = G/B = 0.10. Ten units of monitoring are necessary to achieve q = 0.10. Topic: Monitoring 14) Suppose an employer has monitoring devices established so that the probability of an employee being caught while shirking is 0.2. If the gain to the employee from shirking is $1,000, how large a bond will deter shirking? Answer: B = 1000/0.2 = $5,000. With a $5,000 bond and a 20% chance of being caught, the employee's gain from shirking just equals the expected cost of shirking. Topic: Monitoring

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15) Suppose employees pay a bond of $1,000 to an employer. The gain from shirking is $400. Monitoring devices have been installed so that there is a 50% chance of being caught if you are shirking. The company is considering the installation of additional monitoring devices to increase the chance of catching a shirker to 100%. They feel this is needed to deter all shirking. What is your recommendation to the company? Explain. Answer: Shirking is already deterred; the company does not need any more monitoring devices. The employee gains $400 by shirking but has an expected loss of $500 (loses $1,000 with 50% probability). Topic: Monitoring 19.6 Contract Choice 1) One way to prevent workers from shirking is to A) hire only workers who are predisposed toward shirking. B) hire only workers who are predisposed toward not shirking. C) reduce monitoring to zero. D) pay workers a fixed fee. Answer: B Topic: Contract Choice 2) Firms that seek to avoid hiring lazy workers that assert they are hardworking are trying to avoid A) adverse selection. B) moral hazard. C) screening. D) signaling. Answer: A Topic: Contract Choice 3) A good salesperson can sell $1,000,000 worth of goods, while a poor one can sell only $100,000 worth of goods. Job applicants know if they are good or bad, but the firm does not. A firm will offer job applicants a choice between a fixed salary or a 20% commission. Assuming risk-neutral salespersons and no opportunistic behavior, what level must the fixed salary be so that the firm can determine a prospective good salesperson from a poor one? A) between $0 and $20,000 B) between $20,000 and $200,000 C) greater than $200,000 D) zero Answer: B Topic: Contract Choice 4) If good salespeople are extremely risk averse, then a choice between a fixed-fee contract and a contingent contract A) avoids a moral hazard. B) will result in all job candidates choosing the contingent contract. C) will result in an efficient contract. D) may not be a good screening device. Answer: D Topic: Contract Choice
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For the following, please answer "True" or "False" and explain why. 5) A trade-off typically exists between incurring a moral hazard and making an adverse selection. Answer: False. In fact, making an adverse selection sets up a moral hazard. Conversely, preventing an adverse selection from taking place can prevent a moral hazard as well. Topic: Contract Choice 6) A good salesperson can sell $1,000,000 worth of goods, while a poor one can sell only $100,000 worth of goods. Job applicants know if they are good or bad, but the firm does not. A firm will offer job applicants a choice between a fixed salary or 20% commission. Assuming risk-neutral salespersons and no opportunistic behavior, what level must the fixed salary be so that the firm can distinguish a prospective good salesperson from a poor one, and thereby avoid hiring a poor one? Answer: Under commission, a good salesperson will earn $200,000 and a poor salesperson will earn $20,000. A fixed salary that is above $20,000 but less than $200,000 would be preferred only by poor salespersons. Topic: Contract Choice 7) A good salesperson can sell $1,000,000 worth of goods, while a poor one can sell only $100,000 worth of goods. Job applicants know if they are good or bad, but the firm does not. A firm will offer job applicants a choice between a fixed salary of $25,000 or 20% commission. Assuming risk-neutral salespersons and the possibility of opportunistic behavior, will this choice of contracts allow the firm to distinguish between good salespersons and bad ones before the hiring decision is made? Answer: Under commission, a good salesperson will earn $200,000 and a poor salesperson will earn $20,000. A fixed salary that is above $20,000 but less than $200,000 would be preferred only by poor salespersons. The $25,000 will work at screening out poor salespersons as long as the income that bad salespersons could earn elsewhere is at least $20,000. If the poor salesperson's opportunity cost of working for this firm is less than $20,000, he might accept the commission plan just to send the false signal that he is a good salesperson, and, therefore, be hired. Topic: Contract Choice

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