Recently, on the news there was a story about how a local city found itself in quite a financial bind due to the contracts the mayor had signed with the employees union. The contracts were so generous that it left the city with very little money for other things, like parks and festivals. Unfortunately, this type of agency problem is not unique. We see similar problems when school boards agree to contracts with teachers unions. However, we shouldn’t think of these outcomes as specific to government officials and public employees’ unions. We can see it in our own class. Throughout the course, you were asked to evaluate your team members’ performances. While there were a couple of people who rated others critically, most rated everyone either at a perfect score of “10” or close to it.
One of the keys to effective management (and economics) is to recognize incentives. In no more than a one page answer, please explain two things. First, explain how both situations (the city and the class) described above are agency problems. (Be sure to identify who is (are) the principal(s) and who is (are) the agent(s).) And second, how can the incentives be changed to get better results for both the listed contracts and for this class?