Name__________________________________________________

Economics Dr. Sauer

Ch 2: Incentives worksheet 1. Think about the relationship between landlords and renters. a. Which party is the agent and which is the principal?

b. Landlords typically require renters to pay security deposits. How does this help to solve the Principal-Agent Problem?

2. Russia and South Africa both produce diamonds. They are considering entering into an agreement where they cooperate by each reduce production to drive up prices. The agreement is not legally binding. The table below illustrates the additional profits that each firm will get (in billions) under various scenarios.

Russia abide South Africa abide $18 cheat $20 $15 $16 $18 $15 $16 cheat $20

Russia If Russia somehow knew for sure that South Africa would abide by the agreement, then Russia will get the highest profits if it ______________. If Russia somehow knew for sure that South Africa would cheat on the agreement, then Russia will get the highest profits if it ______________. Given the above information, we know that Russia will choose to ________________. South Africa If South Africa somehow knew for sure that Russia would abide by the agreement, then South Africa will get the highest profits if it ________________. If South Africa somehow knew for sure that Russia would cheat on the agreement, then South Africa will get the highest profits if it ________________. Given the above information, we know that South Africa will choose to ________________. Outcome Given both Russias and South Africas strategies, Russia will end up with $______ billion and South Africa will end up with $________billion. Explain how this is an example of the Prisoners Dilemma.