Principal-Agent problem

Updated questions

1.    You are the manager of a business in a monopoly market with the following inverse demand function

In addition, assume your production technology is described by the total cost function

C(q) = 500 + 10q

a)    Determine the optimal quantity to produce (q^M), the price you should charge for your product (p^M), and compute the profit of your business.

b)      Determine the market power

1. A business can produce its product in different versions: Version A has a basic design and a lower cost and Version B has an upgraded design and a higher cost of production.  The business knows there are different types of customers, “High” demand (H) and “Low” demand (L), but cannot separate the different types of customers. The number of customers of each type and the maximum each type is willing to pay for the different versions of the product are illustrated in the table. In addition, the table gives the marginal cost of production for each version of the product. 

a)    Assume the business offers the product in Version A only. Determine the optimal price () and compute the profit of the business.

b)    Assume the business offers the product in Version A and Version B. Determine the optimal prices ( and ) and compute the profit of the business.

1. Provide an intuitive explanation of the Principal-Agent problem and discuss any mechanisms used to mitigate the problem. You should use the business owner-manager problem as an illustration.

Provide and intuitive explanation of the Adverse Selection problem and discuss its implications. You should use the health insurance industry as an illustration.