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University of Toronto
December 2023 examination
ECO338F
Instructor: Aloysius Siow
Duration - 3 hours

ALL NON-ELECTRONIC AIDS ALLOWED: OPEN BOOK

Answer all questions. There are 4 questions in total.

Each question is worth 10 point.

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1. A clothing store will receive a new style. The store does not know how popular this new style will be.
If the style is not popular, sales will be slow and the firm will have to offer discounts to sell the new style.
The firm is considering four incentive schemes for its sales staff to sell the new style:
(a) A monthly wage scheme with possible dismissal at the end of each month for low performance.
(b) The same piece rate for each item, new or old style, sold for the season.
(c) The same piece rate for each item, new or old style, sold in the first month. The piece rate for the
new style will be adjusted after the first month.
(d) The same piece rate for each item sold, new or old style, and a bonus for each month to the top 25%
salespersons by volume sold in the new style in that month.
Which incentive scheme will you recommend? You have to compare your preferred scheme to the other
three (3 points for each comparison. 1 point due to grader discretion). You have to say how you will set the
wage and piece rates for each scheme.

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2. (a) Explain why there is up or out for professors in universities but not for teachers in high schools.
(2)
(b) John just obtained his computer science degree. He has a job offer from Microsoft and another offer
from a robotics startup. Jack is risk averse. Which job should he accepted? Explain. (2)
(c) Becker argues that there should be negative assortative matching in spouses by educational attain-
ment. I.e. college graduates marry non-college graduates. Explain why he thinks that. (2)
(d) Marital data shows that there is positive assortative matching in spouses by educational attainment.
I.e. graduates and non-graduates mostly marry their own type. Explain. (2)
(e) Workers who are recommended by weak ties are (1) expected to be more productive but (2) do not
receive higher starting wage offers. Explain. (2)

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3. Lazear (2000) “Performance pay and Productivity” - conducted an empirical analysis to compare worker
productivity at a large autoglass company under two pay schemes. The initial pay scheme was a fixed wage
contract which then changed to a piece rate contract.

Consider the model we discussed in class:

• Workers of different ability, A, exert effort, X, to produce output, e, and receive income Y
• Workers have a utility function given by
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U (Y, X) = Y − X 2
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• Firms care about workers’ output which is given by

e = AX

• Workers receive a utility of 0 if they choose not to work

• Fixed Wage Contract
– A fixed-wage contract takes the form (W ; e0 ), where W is a fixed dollar amount and e0 is the
minimum required output.
– Workers who do not produce at least e0 do not receive any payment
• Piece Rate Contract
– A piece rate contract pays the worker be − K, which depends on output.
– The pay rate b is the pay rate per unit of output e and K is an implicit cost
– Again the worker can remain unemployed and receive a utility of 0

(a) What do the indifference curves between output and income look like for a worker of ability A ? Draw
the indifference curves below. (2)
(b) Should the indifference curves be steeper or shallower as A increases? Why? (2)
(c) Given a worker of ability A what is the optimal level of effort they exert under a fixed wage contract?
Show yout work (1)
(d) Given your answer to (c) what is the level of ability A∗ that makes the worker indifferent between
working and not working under a fixed wage contract? Show yout work (1)
(e) Given a worker of ability A what is the optimal level of effort they to exert under a piece rate contract?
Show yout work (2)
(f) Given your answer to the previous parts do you expect the dispersion in output between workers to
increase, decrease, or stay the same when moving from a fixed wage scheme to a piece rate pay scheme?
Why? Explain your answer (2)

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4. Benson, Li & Shue (2019) “Promotions & The Peter Principle” - Empirically ask whether firms
promote the best workers in their current jobs or the best potential managers. The authors use data on the
performance and promotion of sales workers at a set of firms.

Part A The authors first examine whether better sales workers are more likely to be promoted. To do so
they run the following regression:

promoteif t = a1 ln salesif t + Xif t + ϵif t

Where promoteif t is a dummy variable indicating whether worker i at firm f was promoted in period t. The
variable ln salesif t is the log of sales in dollars made by this worker. The covariates Xif t are a set of worker
characterisitcs such as tenure at the firm as well as a set of firm and year indicator dummies. Their results
are presented in the table below:

(a) Why do the authors need to control for the type of firm and the year when running the above regression
by including Xif t ? (2)

(b) The monthly promotion rate is 0.23%. That is every month whenever a promotion takes place this is
the fraction of workers who get promoted. Focusing on column (2) - How does doubling sales change
the probabilty of promotion? Give your answer in percent (%) and show all your work (2)
(c) Focusing on column (4)- How does being the top sales worker change the probability of promotion?
Give your answer in percent (%) and show all your work (2)

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Part B In the second part of the paper the authors estimate managers’ value added. To do so they examine
sales output of different workers under different managers. Where output of workers is measured in dollars of
sales. Value added is estimated by looking at how sales output changes when the team composition changes.

Assume we have the following scenario: Two different managers M 1, M 2 supervise two different workers
W 1, W 2. The following is the sales in dollars for each manager-worker pair. For example S(M1,W1) is the
sales in dollars of worker W1 when being supervised by manager M1
• S(M1,W1) = 50

• S(M1,W2) = 200
• S(M2,W1) = 100
• S(M2,W2) = 300

(d) What is the value added of worker 2 relative to worker 1 ? Show all your work (2)
(e) What is the value added of manager 2 relative to manager 1 ? Show all your work (2)

Hint: Recall the example we discussed in class

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