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After graduating, you start up your own company and need to hire staff. You can assign an employee either an advanced or a basic task. The advanced task earns your company £30,000 per year, and the basic task £20,000 per year. There are two types of job applicant who may be more or less talented. An employee's total cost of working (e.g. due to the disutility from the effort that it takes to complete a task) at your company depends on the type and the task in the following way. Employee's cost of working Advanced task Basic task £25,000 £16,000 £18,000 £11,000 An applicant will agree to work at your company as long as their annual salary is at least equal to their cost of working. You can only observe whether an employee completes the assigned task, but you do not know which type an applicant is. However, you know that exactly half of all applicants on the labour market are of each type. Less talented More talented (a) Suppose you want to offer a menu of employment contracts such that different types of applicants self-select into different menu options. Explain what the "screening device" in this example is, and which option you would want each type of applicant to self-select into. (b) Determine the optimal one among all screening contracts, and your expected profit under this contract. (c) Discuss whether the contract that you found in part (b) is also the optimal one among all (screening and non-screening) contracts. (d) Use your results to briefly discuss the trade-off between rent extraction and efficiency in contracting situations with incomplete information.

After graduating, you start up your own company and need to hire staff. You can assign an employee either an advanced or a basic task. The advanced task earns your company £30,000 per year, and the basic task £20,000 per year. There are two types of job applicant who may be more or less talented. An employee's total cost of working (e.g. due to the disutility from the effort that it takes to complete a task) at your company depends on the type and the task in the following way. Employee's cost of working Advanced task Basic task £25,000 £16,000 £18,000 £11,000 An applicant will agree to work at your company as long as their annual salary is at least equal to their cost of working. You can only observe whether an employee completes the assigned task, but you do not know which type an applicant is. However, you know that exactly half of all applicants on the labour market are of each type. Less talented More talented (a) Suppose you want to offer a menu of employment contracts such that different types of applicants self-select into different menu options. Explain what the "screening device" in this example is, and which option you would want each type of applicant to self-select into. (b) Determine the optimal one among all screening contracts, and your expected profit under this contract. (c) Discuss whether the contract that you found in part (b) is also the optimal one among all (screening and non-screening) contracts. (d) Use your results to briefly discuss the trade-off between rent extraction and efficiency in contracting situations with incomplete information.

Managerial Economics: A Problem Solving Approach
Managerial Economics: A Problem Solving Approach
5th Edition
ISBN:9781337106665
Author:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Chapter17: Making Decisions With Uncertainty
Section: Chapter Questions
Problem 17.6IP
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Question 4 After graduating, you start up your own company and need to hire staff. You can assign an employee either an advanced or a basic task. The advanced task earns your company £30,000 per year, and the basic task £20,000 per year. There are two types of job applicant, who may be more or less talented. An employee's total cost of working (e.g. due to the disutility from the effort that it takes to complete a task) at your company depends on the type and the task in the following way. Employee's cost of working Advanced task Basic task Less talented £25,000 £16,000 More talented £18,000 £11,000 An applicant will agree to work at your company as long as their annual salary is at least equal to their cost of working. You can only observe whether an employee completes the assigned task, but you do not know which type an applicant is. However, you know that exactly half of all applicants on the labour market are of each type. (a) Suppose you want to offer a menu of employment contracts such that different types of applicants self-select into different menu options. Explain what the "screening device" in this example is, and which option you would want each type of applicant to self-select into. (b) Determine the optimal one among all screening contracts, and your expected profit under this contract. (c) Discuss whether the contract that you found in part (b) is also the optimal one among all (screening and non-screening) contracts. (d) Use your results to briefly discuss the trade-off between rent extraction and efficiency in contracting situations with incomplete information.
Transcribed Image Text:Question 4 After graduating, you start up your own company and need to hire staff. You can assign an employee either an advanced or a basic task. The advanced task earns your company £30,000 per year, and the basic task £20,000 per year. There are two types of job applicant, who may be more or less talented. An employee's total cost of working (e.g. due to the disutility from the effort that it takes to complete a task) at your company depends on the type and the task in the following way. Employee's cost of working Advanced task Basic task Less talented £25,000 £16,000 More talented £18,000 £11,000 An applicant will agree to work at your company as long as their annual salary is at least equal to their cost of working. You can only observe whether an employee completes the assigned task, but you do not know which type an applicant is. However, you know that exactly half of all applicants on the labour market are of each type. (a) Suppose you want to offer a menu of employment contracts such that different types of applicants self-select into different menu options. Explain what the "screening device" in this example is, and which option you would want each type of applicant to self-select into. (b) Determine the optimal one among all screening contracts, and your expected profit under this contract. (c) Discuss whether the contract that you found in part (b) is also the optimal one among all (screening and non-screening) contracts. (d) Use your results to briefly discuss the trade-off between rent extraction and efficiency in contracting situations with incomplete information.
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