EC335 Lecture Notes - Lecture 14: Risk Aversion, Risk Neutral
Document Summary
A company is only as good as its employees. It is vital to incentivize them properly to get them to work their hardest. The relationship between employees and the employer is called the principal agent relationship. The principal cares about the difference between the value if receives from its workers and the price of the worker (the wage) The goals of the two are not aligned and this creates a problem. It is the goal of the principal to create the most optimal contract for this relationship. By aligning the interest of the agent and principal, the problem can be resolved. One way is to make the agents wages ties to performance. In economies, we assume an individuals cost function in convex. As a person exerts more effort, the extra effort costs more than the effort that is being exerted. For some companies, observing effort can be straight forward (i. e. quantity base)
