A firm manufacturing cheese sandwiches is interested in attaining only the highest
quality cheese sandwich makers. To screen out the lower quality cheese sandwich
makers, the firm hires successful applicants into a one-year probationary period. At
the end of the one-year period, the firm will decide whether or not to keep a cheese
sandwich maker based on a review of their cheese sandwich making ability during
the probationary period. Should the cheese sandwich maker be kept on, they will
earn a higher salary for their remaining years of producing cheese sandwiches. The
cheese sandwich factory typically finds that cheese sandwich makers stay with
them for 20 years in total (probation + non-probation years). Highly skilled
labour can earn $35/hour at other cheese sandwich making operations while low
skilled labour can earn $25/hour working at call-centres. Assume workers
compensated for 2,000 hours per year regardless of where they work.
Part A: [5 marks] Given the above information, derive a set of equations that will
produce a pre- and post-probationary wage which will only entice highly skilled
cheese sandwich makers to apply to the cheese sandwich factory. Ignore present
value calculations and assume the post-probationary wage and outside opportunity
wages will not change for the duration of employment. (Hint: Do not simply
present the formulas provided in class without showing where they came from.)
Part B: [5 marks] Consider four different scenarios regarding the probability of
detecting poor cheese sandwich making: 75 percent, 90 percent, 95 percent, and 99
percent. In each case determine the pre- and post-probationary wages that will
only entice highly skilled cheese sandwich workers to apply. Explain your results.
Part C: [5 marks] Using your equations derived in Part A, re-calculate Part B
given outside opportunities are such that highly skilled labour can earn $25/hour
and low skilled labour can earn $23/hour. Explain your results.
In exhibition and leisurely jousting matches (i.e. riding horses with long swords
known as lances), it is very common to \handicap” players of different ability. For
example, a better jouster is given a shorter lance when jousting against an inferior
jouster. The better jouster is assigned this shorter joust at the beginning of the
match and must use it for the entire duration.
Part A: [5 marks] Why is this done? What are the incentive effects of giving a
novice jouster a longer lance? Would it make sense to do this in a professional
jousting match (assuming there is such a thing)? Why or why not?
Now consider a firm that manufacturers lances (Lance-mart). Suppose Lance-mart
uses a promotion-based incentive system for middle managers based on
performance ratings over a number of years.
Part B: [5 marks] The firm notices that the system is not generating strong
incentives for either front-runners (with good past performance reviews) or
underdogs (with weak past performance reviews). Why might this be the case?
Can you recommend a better strategy?