Question

The owner of ABC Corporation decides to hire Jack as the manager. The profit of ABC primarily depends on how much effort Jack puts on the management, as follows:

	Probabilities
	$10,000	$90,000
Low effort	70%	30%
High effort	10%	90%

      Jack thinks choosing “low effort” is costless and choosing “high effort” costs him $2,000. The owner cannot observe which effort level that Jack chooses. How can the owner do to induce Jack to choose “high effort”?

Answer 1

For taking decision ABC Corporation should calculate profitability in both effort and if profitability under high effort is more than $2,000 then ABC should induce Jack to choose "high effort" by incurring $2,000 as costs.

Profitability under Low Effort = $10,000 * 70% + $ 90,000 * 30% = $34,000

Profitability under High Effort = [$10,000 * 10% + $ 90,000 * 90%] - $2,000 = $80,000

Since The profitability under High Effort is more than profitability under Low Effort then ABC Corporation induce Jack to choose "High Effort" by citing reason as high profitability in choosing the best alternative.