Economics 174

Problem Set 2 -- Due Monday, May 3

These questions are due at the beginning of class, May 3.  Sample solutions will be available on the web shortly thereafter.

These are designed to be answered in a paragraph or two on the average.  Write as much as you need toward providing a clear and full response to the question, but no more.

If you want more practice with the material, additional problem set questions (from when I previously taught this class) are on the web.  Solutions will be available to these questions as well after May 3.

Good luck!

1.    Define "greenmail."  Discuss the role greenmail plays in the market for corporate control.  Be sure to discuss whether it is likely efficiency-enhancing or not, and why.

2 . In Jensen and Meckling's model, managers who own less than 100% of the firm are unable to guarantee shareholders that they will make the same decisions they would if they were
sole owners. Why is this costly? What individual or group of individuals bear these costs? What assumption concerning individuals' foresight drives this result?

3.    You are the owner of a small trucking firm in LA.  You employ several similarly risk averse drivers who value both income and leisure.  The firm's output, and thus profit, is a function
of your drivers' effort -- high effort levels mean that your firm is able to serve more customers because your trucks are on the road and moving more of the time.  Effort, however, is costly
to drivers.

Assume that individual truck drivers' output is observable (the number of "hauls" he makes, how long they are, etc.) to you.  Output is a function of driver effort and of factors outside of
his control, such as traffic.  Assume that you can directly observe only output and not effort.

Your drivers run two types of routes.  One goes back and forth between West LA and Bakersfield.  On the average, there is very little traffic, and not much difference in the traffic from
day to day.  The other goes back and forth between West LA and Pomona.  Because it goes through Downtown LA, this route tends to have a lot of traffic, and a lot of variablility in

You are trying to design optimal compensation contracts for drivers on these different routes.  Compensation consists of a fixed wage plus a per-mile rate.  Assume that the market for
truck drivers is perfectly competitive -- truck drivers' utility from working for you is the same as that in their next best opportunity.

You hook yourself up to the internet.  On its website, Caltrans has a page which offers up to date traffic reports on all major Southern California highways.  This provides a good, but
imperfect, signal of the conditions your drivers face.

4. Firms often find it difficult to monitor their workers' use of telephones. For example, when I worked for the Council of Economic Advisers in Washington, there was no monitoring
whatsoever. Furthermore, there was no accounting system to track the location, length, and cost of long distance telephone calls. As a result, my coworkers and I frequently made
lengthy long distance phone calls from office phones. There were even instances where individuals came into work on the weekends for the sole purpose of making long distance calls.

Suppose the press got wind of this, and in the ensuing media uproar, the Federal Government announced that it was going to implement a new system to monitor telephone usage. At the
end of each day, individuals would receive a print-out of describing each telephone call they made. Unless they could provide evidence that a call was for legitimate government
business, the cost of the call would be deducted from their (after tax) pay.