A risk-neutral firm produces chemical products, and its objective is to maximize expected profit. There is a risk that there will be an accident during the production process, and dangerous chemical products will be released into the ocean, polluting the water. To reduce the risk of an accident, the firm can choose Low or High investment in safety. Low Investment in Safety. Cost for firm= $0 Probability of an Accident = 80% Probability of No Accident =20% High Investment in Safety Cost for firm= $150 Probability of an Accident = 20% Probability of No Accident = 80% The Government wants to reduce the risk of an accident, but the Government cannot observe the fir m's investment in safety. Therefore there is a moral hazard problem. However, the Government can observe whether an accident occurred or not. So the government decides to create a fine (penalty): if an accident occurs, the firm must pay a fine F to the Government. If an accident does not occurs, then the firm does not have to pay nothing. Compute the minimum fine F that the Government must impose, in order to solve the moral hazard problem and guarantee that the firm will choose the high investment in safety

A risk-neutral firm produces chemical products, and its objective is to maximize expected profit. There is a risk that there will be an accident during the production process, and dangerous chemical products will be released into the ocean, polluting the water. To reduce the risk of an accident, the firm can choose Low or High investment in safety. Low Investment in Safety. Cost for firm= $0 Probability of an Accident = 80% Probability of No Accident =20% High Investment in Safety Cost for firm= $150 Probability of an Accident = 20% Probability of No Accident = 80% The Government wants to reduce the risk of an accident, but the Government cannot observe the fir m's investment in safety. Therefore there is a moral hazard problem. However, the Government can observe whether an accident occurred or not. So the government decides to create a fine (penalty): if an accident occurs, the firm must pay a fine F to the Government. If an accident does not occurs, then the firm does not have to pay nothing. Compute the minimum fine F that the Government must impose, in order to solve the moral hazard problem and guarantee that the firm will choose the high investment in safety

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter18: Asymmetric Information

Section: Chapter Questions

Problem 18.5P

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