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Simple menus of cost‐based contracts with monotone optimal effort
Author(s) -
An Yonghong,
Zhang Daiqiang
Publication year - 2018
Publication title -
journal of public economic theory
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.809
H-Index - 32
eISSN - 1467-9779
pISSN - 1097-3923
DOI - 10.1111/jpet.12302
Subject(s) - monotone polygon , monotonic function , simple (philosophy) , mathematical optimization , principal (computer security) , computer science , type (biology) , microeconomics , economics , mathematical economics , mathematics , mathematical analysis , ecology , philosophy , geometry , epistemology , biology , operating system
This paper extends the fixed‐price cost‐reimbursement (FPCR) menu by allowing the agent's cost‐reducing optimal effort to be monotone in the agent's cost type. We show that the performance of the optimal FPCR menu relies crucially on the monotonicity of optimal effort. In particular, in an optimal FPCR menu, if the optimal effort is increasing in type and only a portion of cost types are induced to exert effort, the performance of the optimal FPCR menu can be very poor relative to the fully optimal contract. Our results suggest that in designing an optimal FPCR menu it is important for the principal to take into account the cost structure or, more exactly, the monotonicity of optimal effort in type.