Reference no: EM1365411

Question #1: Hedonic Wage Theory and Employee Benefits

Consider a worker that ranks combinations of employee benefits (B) and wages (W) accord­ing to the utility function:

U(B,W) = B^αW^β  ,

where α and β are positive constants and U is the satisfaction level. If firms do offer benefits, wages must be reduced by 95 cents for every dollar of benefits offered, in order for the firm to continue to break even. Suppose that a firm currently offers a compensation package of $40 in benefits and $60 in wages. Assume that an individual's preferences are such that α = 1 and β = 2 (i.e.: they give more weight to wages than to benefits in the process of ranking compensation packages).

1.  Why might such a weighting occur?

2.  What is the utility level associated with the firm's current compensation package?

3.  How much would this individual be willing to give up for a $20 increase in benefits? What would such an increase in benefits cost the firm? By how much would the firm cut wages? Would the worker be made better off by such an increase in benefits?

Suppose that workers preferences are now such that a and β are both given an equal weight of one.

4.  Given the original compensation package, how much would the individual be willing to give up for a $20 increase in benefits? What would such an increase cost the firm? By how much would the firm cut wages? Would the worker be made better off by such an increase in benefits?

Question #2: Risk and earnings

Consider an economy with many different types of jobs and workers. A researcher has constructed a data set that records the earnings of a worker in each type of job as well as the risk of injury. The researcher finds that a 1% increase in injury risk is associated with a 0.5% increase in earnings. Yet, when the researcher asks any worker in the economy if he or she would be willing to pay 0.5% of his or her earnings in return for a 1% reduction in risk, the offer is always refused. Similarly, if offered a 0.5% increase in earnings in return for a 1% increase in risk, again the offer is always refused. Is this behavior consistent with the theory of compensating differentials? Explain.

Question# 3: Teacher Quality and Compensating Wage Differentials

Consider the labor market for public school teachers. Teachers have preferences over their job characteristics and amenities.

1. One would reasonably expect that high-crime school districts pay higher wages than low-crime school districts. But the data consistently reveal that high-crime school districts pay lower wages than low-crime school districts. Why?

2. Does your discussion suggest anything about the relation between teacher salaries and school quality?