case? Under this setup, is there a danger of overtreatment? Why or
why not?- Firm X has promised to deliver an order of industrial parts to firm Y.
However, there is a small chance that firm X will have so many orders
from customers that it cannot fulfill them all. If its order is not filled,
firm Y’s profit will fall by $100,000. If customer demand exceeds capacity,
firm X’s cost of fulfilling firm Y’s order might turn out to be anywhere
between $50,000 and $150,000.
a. Consider a contract in which firm X must guarantee delivery to firm
Y. Explain when and why such a contract leads to inefficient actions
and outcomes.
b. Alternatively, suppose the contract has a penalty provision: If firm X
doesn’t deliver, it pays a penalty of $50,000 to firm Y. Does this
contract lead to efficient outcomes? Why or why not? What if the
penalty for nondelivery is set at $100,000 instead? - When a corporation offers shares of stock or other securities to the
public, it hires an underwriter to conduct the sale. (The underwriter is
an investment bank such as Morgan Stanley or Goldman Sachs.) Most
commonly, firms and investment bankers use a procedure known as
“firm commitment” underwriting. In this arrangement, the underwriter
buys the shares from the company and then sells them to the public. If
the offering is undersubscribed or if the price must be subsequently
lowered to unload the shares, the underwriter, not the firm, suffers the
loss. Why do firms and underwriters use this procedure? What is in it for
each? How does this means of sale affect the buying public? - Since the mid-1980s, baseball teams have bid vigorously for free agents—
players with six or more years of service who are free to sign with a new
team. After signing a five-year contract with a new team for an exorbitant
amount, a free-agent pitcher has had three consecutive lackluster seasons.
a. How might adverse selection explain this outcome?
b. How might moral hazard cause this outcome? Explain.
c. What advice would you give owners in bidding for free agents? - Many companies give out perquisites (the corner office, company cars,
etc.) strictly on the basis of seniority. Likewise, companies frequently
allocate tasks based on seniority. For example, many airlines assign
routes to pilots and flight attendants based on seniority. What are the
advantages and disadvantages of the seniority system? - Team decision making frequently mitigates information and
coordination problems. What are some of the costs of teams? - For planning purposes, company headquarters seeks to obtain accurate
information about the productive capacity of one of its plants. The plant
manager knows that the facility’s capacity is Q 10,000 units, but knows
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