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ECON5323 Organisational Economics Lecture 7-Choosing Workers Part II
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ECON5323 Organisational Economics Lecture 7-Choosing Workers Part II
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ECON5323 Organisational EconomicsChoosing workers Part II
, Worker screening: a more formal approach
• We will now develop a more formal model of screening starting from the
worker example at the beginning of this section
• two types of workers, good and bad
• good worker produces more and has a lower cost of effort, bad worker
produces less and has a higher cost of effort
• Now, we take a more realistic approach: instead of assuming that
effort/production is predetermined, we will develop a model in which both
types of worker can exert effort on a continuum, and incur costs that are a
function of their chosen effort level
• We are still focusing on adverse selection only and abstracting away from
moral hazard, so we assume effort is observable and contractible
• This framework will allow us to see how job contracts that specify salary
and responsibilities can also serve as a screening mechanism
, Worker screening: a more formal approach
• There are two types of workers, good and bad, with good workers comprising
share s of the worker population and bad workers comprising 1 − 𝑠.
• Payoffs for each type depend on effort and wage:
1 "
𝑈! = 𝑤! − 𝑒
𝜃! !
1
𝑈# = 𝑤# − 𝑒#"
𝜃#
where outside option payoff is 0 for both types and where 𝜃! > 𝜃#.
• That is, the good worker has a lower cost of effort than the bad worker
• Here, effort can be thought of as exertion, complexity of assigned tasks, or
degree of responsibility inherent in the job they are doing
, Worker screening: a more formal approach
• The employer values e - that is, his profits increase if he has a worker
exerting more effort/taking on more responsibility/handling more complex
tasks
• The employer’s profits decrease in the wages he must pay, so his per
worker profits are equal to
𝑒$ − 𝑤$
• The employer offers a “menu” of contracts (𝑤!, 𝑒!) and (𝑤#, 𝑒#) and lets
workers sort themselves into which contract they want to apply for (if
any!). If he offers contracts such that both types want to take the job, his
total profits are equal to
𝑠 𝑒! − 𝑤! + (1 − 𝑠)(𝑒# − 𝑤#)
• But if (for example) only bad types apply for the “bad” contract, his
profits are
(1 − 𝑠)(𝑒# − 𝑤#)
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