Part 1

1. Marge owns a lawn mowing company. She has 400 lawns she needs to cut each week. Her
weekly revenue from these 400 lawns is $20,000. If given an 18-inch deck push (hand)
mower, a low-skill worker can cut each lawn in two hours. If given a 60-inch deck ride-on
mower, a low-skill worker can cut the lawn in 30 minutes. Low-skilled labor is supplied
inelastically at $5.00 per hour. Each laborer works 8 hours a day and 5 days each week.
i If Marge decides to have her workers use push(hand) mowers, how many push (hand)
mowers will Marge rent and how many workers will she hire? (2 marks)
Because each worker can cut a lawn in 2 hours, this means that each worker can cut 4 lawns a day
which is also equivalent to 20 lawns a week. Thus, Marge would need to rent 20 push mowers
and hire 20 workers in order to cut all 400 lawns each week.
ii If she decides to have her workers use ride-on mowers, how many ride-on mowers will
Marge rent and how many workers will she hire? (2 marks)
For every worker , each can cut a lawn in 2 hours which is also equivalent to each worker being
able to cut 4 lawns in a day or 20 lawns in a week. Thus, Marge would need to rent 20 push
mowers and hire 20 workers in order to cut all 400 lawns each week.
iii Suppose the weekly rental cost (including petrol and maintenance) for each push (hand)
mower is $250 and the weekly rental cost (including petrol and maintenance) of each rideon mower is $1,800. What equipment will Marge rent? How many workers will she employ?
How much profit will she earn? (2 marks)
If Marge were to use push mowers, her weekly cost of mowers is $250(20)=%5,000 while her
weekly labour cost will be : $5(20)(40)=$4,000.
This would bring here weekly profit to $11,000.
If Marge were to ride-on mowers, her weekly cost of mowers will be $1,800(5)=$9,000 and her
weekly labour cost will be : $5(5)(40)=$1,000.
This would bring her weekly profit to $10,000.
Thus, Marge will rent 20 push mowers and employ 20 low-skill workers.
iv Suppose the government imposes a 20 percent payroll tax (paid by employers) on all
labor and offers a 20 percent subsidy on the rental cost of capital. What equipment will
Marge rent? How much profit will she earn?
Under these conditions, the cost of labour has increased to $6.00 per hour, while the rental costs
for a push mower and a riding mower have decreased to $200 and $1,440 respectively.Marges
profits under the two options, therefore, are :
Push-Profit = $20,000 $200(20) $6(20)(40) = $11,200.
Rider-Profit = $20,000 $1,440(5) $6(5)(40) = $11,600.
Thus, under these conditions, Marge rents riding mowers, hires 5 low-skill
workers, and earns a weekly profit of $11,600.

2. Suppose a firms technology requires it to hire 200 workers regardless of the wage level. The
firm, however, has found that worker productivity is greatly affected by its wage. The historical
relationship between the wage level and the firms output is given by:
Wage Rate
$ 8.00
$ 10.00
$ 11.25
$ 12.00
$ 12.50

Units of Output
68
80
90
97
102

(i) What (efficiency) wage level should a profit-maximising firm choose? (2 marks)
In order to find the efficiency wage, we first have to determine the condition that
elasticity must equal to 1. At the wage rate from $10.00 to $11.25 : [(90-80)/80]
/ [(11.25-10)/10] = 1
Thus, a profit-maximizing firm should choose the wage rate at $11.25.

(ii) What happens to the efficiency wage if there is an increase in the demand for the firms
output? (1 mark)
There won't be any effect since on the efficiency wage since it is independent of any labour market
conditions, and does not depend on the demand for the firm's output.

(iii) What is the link between efficiency wages and shirking? There are two firms A and B
identical in all respects except the following. In firm A increased expenditure on monitoring
costs will lead to increased detection of shirking. In firm B monitoring is more difficult and
expenditure on monitoring costs has no effect on detection of shirking. If both firms pay
efficiency wages, which firm will pay the greatest efficiency wage?
(2 marks)

Firm B will pay the greatest efficiency wage. This is because efficiency wage hypothesis argues
that wages, at least in some markets, form in a way that is not market-clearing. Specifically, it
points to the incentive for managers to pay their employees more than the market-clearing wage
in order to increase their productivity or efficiency, or reduce costs associated with turnover, in
industries where the costs of replacing labour is high. This increases labour productivity and/or
decreased costs pay for the higher wages.

Part 2
(a) Below are 3 statements about promotion incentives and relative evaluation. First decide if
they are correct or not and briefly explain why you did or did not decide if they are correct.
i. Ordinal evaluations (rankings) are usually less accurate than cardinal evaluations (level of
performance).
Correct. Ordinal evaluations are usually less accurate simply because in many cases, though it's easy
to determine who the best performer but in does not take into full account of the effort and hardship
the employee has put in and performed. For example, when choosing between a lumps of coal, the
larger piece may not necessarily weigh more despite its large size(Lazear & Gibbs,2008).
ii. In deciding who to promote, there is a tradeoffs between quality and quantity. If you promote
based on a tournament (competition), you know how many will be promoted but not how
good they are. If you promote based on an absolute performance standard, you control quality
of those promoted, but not quantity. There is no way to avoid this tradeoffs.
Correct. There is no way to avoid this trade off between both quality and quantity as there is a major
difference between them. Standards give better control over quality, and tournaments give better
control over quantity. The costs and benefits of these determine the extent to which a firm uses either.
However, that if the firm does not have perfect flexibility in the number promoted, then actions taken
by one worker affect the chances of all others eligible for promotion(Lazear & Gibbs,2008). This is
precisely the definition of a tournament. Therefore, many promotions unavoidably have a tournamentlike aspect to them.
iii. Relative evaluation (benchmarking) generally reduces performance measure risk, without
distorting incentives.
False. Relative evaluation (benchmarking) generally(might) reduces performance measure risk
without distorting incentives. Relative evaluation reduces the incentive for workers to cooperate on
the job. This can be a serious downside to RPE, since most jobs are interdependent with those of
colleagues to some extent.

(b) Due to poor financial performance, a firm has to lay off

employees. The head of HR would like to lay off those employees for
which the firms (firm-specific) human capital investments have the
smallest net present value. Would those employees be the ones with
shortest tenure with the firm, medium tenure with the firm, or
longest tenure with the firm? Explain briefly.
Those employees would be ones with shortest tenure. These however
depends on a few factors. For example, most countries have legal
requirements governing redundancies or retrenchment with heavier
compensations required to retrench employees with longer years of service.
Since the head of HR would like to lay off employees for which firm's human
capital investment which have the smallest net present value, this makes it
more costly to retrench the longer tenure employees and because they
posses higher skill level and knowledge of that firm.

Reference
Lazear, E. P., & Gibbs, M. (2008). Paying for Performance. Personnel economics in
practice (2nd ed., ). Hoboken, NJ: John Wiley & Sons.