Consider a workplace that has two workers who can work as a team. Each worker can put in effort; worker 1's effort is labelled e1 and worker 2's as e2. These effort choices are made simultaneously. Output of the team is 8e1 + 4e2. Each worker bears the cost of their effort and has a utility of Ui = wi - ei2, where i = 1,2 and wi is the wage that the worker receives. a. What are the first-best (surplus-maximising) efforts for each worker? (2 marks) b. Now assume that the effort of each worker is unobservable but team output can be contracted on. In fact, assume that the balanced-budget rule holds in that each worker receives half of team output as their wage. What are the efforts that each workers put in. Explain the differences (or similarities) between your answer here and that for part a. Use a diagram to help explain your answer. (6 marks) c. Assume now that one of the workers can become the 'owner' of the operation. The worker who owns the firm is able to keep all of the team output for themselves (each worker continues to bear their own cost of effort, regardless as to who is the owner and effort continues to be non-contractable). Consider the three possible ownership structures: worker 1 ownership; worker 2 ownership; and joint ownership, which is the same as part b (that is a 50:50 split of team output). Which is better and why? Relate your answer to the property-right model studied in class. (6 marks) d. Outline the key intuition of the property-right model. What are the key predictions? What are the limitations of the model?
