5. Payment Schemes

Question 1

Personnel economics

Answer 1

Dealing with the personnel management within firms and thus internal labour economics

Question 2

What is the aim of payment schemes?

Answer 2

•to maximise output per person per hour whilst also being accepted as equitable by the employees

Question 3

What does the employment relationship create?

Answer 3

A principal agent problem with moral hazard and adverse selection

Question 4

How much monitoring will a profit maximising firm do?

Answer 4

They will monitor up until the point where the marginal cost of monitoring is equal to the marginal revenue of monitoring

Question 5

Piece rate

Answer 5

A screening devise to economise on supervisory personnel in which the work performance of each employee is costly to detect and hence where the employee has occasion to shirk

Question 6

When are piece rates used more intensively?

Answer 6

•the risk is smaller
•the degree of risk aversion is lower
•the supply elasticity of effort is greater
•in labour jobs
•in larger firms

Question 7

Benefits of piece rate for employer

Answer 7

Incentive for greater effort, attracts most able individuals and keeps them

Question 8

Disadvantages of piece rates

Answer 8

•production often depends on team work
•overemphasises the quantity of output produced rather than quality
•salaries could fluctuate over time- firms to compensate workers for this
•ratchet effect- when you perform the task successfully, the employer makes the next task harder for the same payment

Question 9

Results of auto glass case study

Answer 9

•productivity increased by 44%. 22% of which was due to productivity increase of workers, the rest was explained by sorting effects
•cost per unit fell

Question 10

Tournament theory

Answer 10

The idea that salaries are pre determined and differences in salaries within a company are on the basis of relative performance rather than absolute performance

Question 11

What are the main features of tournament theory

Answer 11

•prizes are fixed in advance, independent of absolute performance
•job positions are fixed in advance
•wages that go to managers are pre determined
•the effort exterted by workers to get a promotion depends on the wage increase

Question 12

What is the equation for expected earnings in a 2 player tournament theory

Answer 12

Expected earnings = Wh(P)+ WL(1-P)- C(U)

Question 13

How is effort effected in tournament theory when g(0) falls?

Answer 13

Effort falls since luck plays a bigger role in determining the winner

Question 14

What is the empirical evidence on tournament theory?

Answer 14

There is lots of evidence for tournament theory in firms even though data within firms is hard to find

Question 15

Why do not all promotions satisfy tournament theory?

Answer 15

•some rewards are relatively small, 2-3% pay rises
•winners are sometimes easy to predict

Question 16

What is delayed compensation?

Answer 16

Workers are initially paid a wage less than their VMP and later paid more than their VMP in order to discourage shirking

Question 17

What are the risks of delayed compensation for the worker?

Answer 17

•doesn’t allow for career change
•may be worried about getting fired
•firm may go bankrupt

Question 18

What do empirical tests for delayed compensation suffer from?

Answer 18

Observing productivity

Question 19

What does empirical evidence of delayed compensation find?

Answer 19

Senior workers with the same skill level earn more than younger earners

Question 20

Efficiency wages

Answer 20

Refers to paying a wage above the market rate in order to increase productivity

Question 21

When should wages be increased until?

Answer 21

Until the MC of increasing the wage is equal to the MB in the workers productivity

Question 22

Why pay higher wages?

Answer 22

•better nutrition for workers (developing countries)
•inability to monitor worker’s effort- reduces shirking
•attracts highly skilled workers
•builds loyalty among workers
•prevents unions forming

Question 23

Why do inter industry wage differentials occur?

Answer 23

•in some industries it may be profitable to pay above the competitive wage, while in other industries it isn’t
•these differentials may reflect compensating wages
•could be differences in unobserved characteristics of workers which differ systematically across industries due to a selection bias

Question 24

Bonding critique

Answer 24

The idea that efficiency wages should self destruct in the LR. If firms use higher wages, workers should be willing to pay an up front performance bond