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26 Lecture%20incentive%20pay%202 - LECTURE 26 INCENTIVE PAY...

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LECTURE 26 INCENTIVE PAY 2
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ANNOUNCEMENTS Today Efficiency Wages Next class: Review Final exam is cumulative! Bring questions
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WHAT IS THE REASON FOR INCENTIVE PAY? All work is not equal – a worker can do an excellent job or a mediocre job All else equal, workers prefer to exert less effort Worker interests are not aligned with maximizing firm profits barb2right principal-agent problem Incentive pay is a way to tie worker compensation to behavior that will maximize firm profit barb2right get them to exert a lot of effort
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CARROT VS. STICK Piece-rate and bonuses tie compensation to productivity outcomes barb2right reward greater effort Tournament – also rewards greater effort directly, but effort is not measured in absolute terms but rather relative terms Alternative – instead of linking pay directly to productivity, use threat of job loss
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THREAT OF JOB LOSS Recall utility is increasing in earnings and decreasing in effort U=U(w,e) Each firm employs monitoring to observe effort level – fire those that are “shirking” When will a worker shirk?
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