Consider a risk neutral employer and a risk neutral employee. The employee can either work hard or not. Let L for low effort or H for high effort correspond to its effort level. If the employee exercises low efforts, then it has an associated cost of 3 to him.But he generates profits for the employer of 8 with propability .5 and 0 with probability of .5 . If the employee exercises low efforts, then it has an associated cost of 4 to him. But he generates profits for the employer of 8 with probability .75 and 0 with probability .25 . Assume that the employee maximizes his pay minus his costs and it has an outside opportunity of 0 (no effort no rewards). If the employer can only offer a take or leave it offer before observing the effort level:

1. Set up the problem the employer faces

2. Set up the problem the employee faces

3. Can the employer offer a wage to induce high efforts?

4. If the employee is willing to wait after the employer sees the outcome to get paid (i.e a bonus scheme) would your answer change? If so, how?

5. If the employer can observe the effort level before he pays his employee, what should he do?

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Elin HesselLv2

7 Apr 2018

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Individals are of two di Â§erent abilities: high (H) and low (L). An individual knows his or her own

ability but an employer does not. Employers believe that both types of individuals are equally likely

in the population, and therefore has an initial (prior) belief that an individual is high ability with

probability 1. Before an individual looks for a job, he or she has an opportunity to go to college. 2

Assume that attending college does not change an individualiÃs ability; this problem shows that even in

this circumstance, college can perform a useful social function. The e Â§ort cost of attending college is

di Â§erent for individuals of di Â§erent abilities. In order to attend college, high ability individuals must

expend e Â§ort 1, and low ability individuals must expend e Â§ort 1, where a < 3 (this means that a 3a

low ability individual has a higher cost of attending college). Not attending college costs 0. After

observing an individualiÃs education (that is, whether he or she attended college) an employer makes

the individual a job o Â§er. The wage that the individual receives is equal to the employeriÃs belief that

the individual is high ability, given the level of schooling that the individual has chosen to acquire. For

example, if the employer believes that a college graduate is high ability with probability 2 he will o Â§er 3

a college graduate a wage of 2 . If he believes that an individal with no college education is high ability 3

with probability 1 , he will o Â§er an individual without college a wage of 1 : An individualiÃs payo Â§ is 44

equal to his wage, minus the cost of education..

First consider a separating equilibrium. In a separating equilibrium, high ability individuals attend college, but low ability individuals do not.

(a) If the employer observes that an individual did not attend college, what is his belief about the individualiÃs ability? What wage will he o Â§er individuals who do not attend college?
(b) If the employer observes that an individual did attend college, what is his belief about the indi- vidualiÃs ability? What wage will he o Â§er individuals who attend college?
(c) Given the wages paid to college graduates and those who do not attend, will the high-ability individual chooose to attend college? (Hint: compare the payo Â§ of attending college for the high ability graduate to the payo Â§ of not attending college)
(d) Given the wages paid to college graduates and those who do not attend, for which values of a will the low-ability individual chooose to attend college? (Hint: compare the payo Â§ of attending college for the low ability graduate to the payo Â§ of not attending college)
(e) In a separating equilibrium, a low ability individual does not attend college. For which values of a is this expectation consistent with the low ability individualiÃs strategy?

Now, consider a pooling equilibrium in which all individuals attend college; that is, both high and low ability individuals attend college. If some individual were to choose not to attend college, the employer would believe that he or she must be low ability, and would o Â§er a wage of 0.
(f) If the employer observes that an individual attended college, what is his belief about the individ- ualiÃs ability? What wage will he o Â§er to college graduates? (Hint: The employer expects that all individuals attend college. This means that attending college conveys no information about the individualiÃs true ability).
(g) Given the wages paid to college graduates (and the wage that would be paid to non-grads) would the high-ability individual choose to attend college? For which values of a would the low ability individual choose to attend college?
(h) In a pooling equilibrium, both high and low ability individuals attend college. For which values of a is this expectation consistent with the individualsiÃstrategies?

Finally, consider a sem-separating equilibrium in which high-ability individuals attend college (for sure), but low ability students attend college with probability 0 < s < 1:
(i) If the employer sees that an individual attends college what is his belief that the individual is high-ability? What is the wage to college graduates? (Hint: Remember, all high ability individuals attend, but low ability individuals attend with probability s. Divide the probability of an individual being high ability and attending college by the overall probability of an individual attending college).

(j) If the employer sees that an individual did not attend college, what are his beliefs about the individualiÃs ability? (Hint: all high ability individuals attend college)
(k) The low-ability individual is willing to randomize between attending college and not attending college. Use this to OÃËnd the probability that the low-ability individual attends in equilibrium.

Bonus: Comment on the purpose of college illustrated in this example. How is this purpose a Â§ected as college becomes easier for the low-ability type (i.e. as a increases)?

lavendergnat675

The main incentive for a company to offer tuition reimbursement is the expectation that employees will expand their knowledge within the field and give a better performance for the company once they have obtained the degree. As the book states, the problem that the principal faces are that the agent has different incentives than the principal, this is called incentive conflict. In this particular example, the company is wanting employees to further educate themselves and so offer the incentive of tuition reimbursement in the effort this will improve the performance of the individual, however, the individual may be wanting to earn the degree for different reasons, such as leaving and moving to another job once they have gained these qualifications for free.

The company needs to be able to control the incentive conflict and need to understand the trade-offs associated with various solutions. Once you give the employee the authority to make decisions you want to be sure that they are motivated to make the choices in the company's best interests. Setting the mark at a grade 'C' or above could be seen as a weak incentive by the employer as a C grade can be obtained going through the motions and could result in the employee not really gaining the knowledge and experience the company is wanting them to achieve. I think holding the employees to a particular standard that is set by the company could help in eliminating some conflict as it would result in employees knowing they have to reach a certain grade to gain the reimbursement and likewise puts the company in a position that they are gaining the education and knowledge they are wanting to help put them ahead of competitors within the market.

Question:

Please comment on this post and answer the following question.

How do you feel about those who obtain a D? Who you want to hire them?

coralclam390

A tobacco company is interested in hiring a salesperson to promote smoking cigarettes in nightclubs. The position pays a flat salary of $50,000, regardless of sales levels. The firm has two applicants, predictable Patty and Risky Ricky. Predictable Patty can produce with 100% certainty $100,000 a year in sales. Risky Ricky, on the other hand, can produce $300,000 with a probability of 50%. But if he turns out to spend his time drinking and dancing in the nightclubs instead of making sales, he could actually cost the firm $100,000 per year. *may want to use Excel spreadsheet to help solve this problem*

A. During their first year on the job, what are the expected sales of Patty and Ricky?

B. Now assume both workers are currently 25, and they will work until the retirement age of 65. The firm has the option to fire its new employee after one year based on sales but can only hire one employee. Assume that it takes only one year to discover whether Ricky is productive or not and that he will remain that way for his lifetime. The firm's discount rate for future profits is fixed at 10% over the life of both workers. Which employee should it hire?