Question 4 - Incentives over the Career (25p) Suppose a person works for a firm in two periods (each period is 20 years) and then retires. The person can work with high or low effort. Exerting high effort, the worker produces a value for the firm of $55,000 per period Working with high effort results in disutility for the worker of $7,000 per period Exerting low effort, the worker produces a value for the firm of $40,000 per period Working with low effort results in no/zero disutility The person can also work for another firm and earn $40,000 per period while exerting low effort Now, assume that at the firm knows the worker's output(effort) and can adjust the salary each period. We have that The salary is $10,000 in period 1, regardless of effort The salary is $80,000 in period 2, if the worker exerts low effort The worker can be fired for exerting low effort in period 1. If fired, the worker can go to the outside option and work with low effort and receive $40,000 in period 2. . Note that high effort still leads to disutility of $7,000 d) (5p) How much must the firm pay in period 2 for the worker to exert high effort? e) (5p) What will be the profit to the firm if the worker exerts high effort in both periods? (Hint:To work with high effort in period 2, the worker has to be compensated for the disu- tility. Hence the salary in period 2 has to be at least $88,000.) Question 4 - Incentives over the Career (25p) Suppose a person works for a firm in two periods (each period is 20 years) and then retires. The person can work with high or low effort. Exerting high effort, the worker produces a value for the firm of $55,000 per period Working with high effort results in disutility for the worker of $7,000 per period Exerting low effort, the worker produces a value for the firm of $40,000 per period Working with low effort results in no/zero disutility The person can also work for another firm and earn $40,000 per period while exerting low effort Now, assume that at the firm knows the worker's output(effort) and can adjust the salary each period. We have that The salary is $10,000 in period 1, regardless of effort The salary is $80,000 in period 2, if the worker exerts low effort The worker can be fired for exerting low effort in period 1. If fired, the worker can go to the outside option and work with low effort and receive $40,000 in period 2. . Note that high effort still leads to disutility of $7,000 d) (5p) How much must the firm pay in period 2 for the worker to exert high effort? e) (5p) What will be the profit to the firm if the worker exerts high effort in both periods? (Hint:To work with high effort in period 2, the worker has to be compensated for the disu- tility. Hence the salary in period 2 has to be at least $88,000.)