A firm uses an efficiency wage scheme to deter workers from shirking,which is detected 10% of the times.Suppose a risk-neutral worker.The industry ongoing wage is $3,000.The efficiency wage paid by this firm is $8,000.What is this worker's reservation wage?
A) $400
B) $500
C) $1,000
D) $1,500

Question

Quizplus · Accepted Answer

The reservation wage is the wage at which a worker is indifferent between working and shirking. If the worker shirks and is caught (which happens 10% of the time), they lose the job and go back to the industry wage of $3,000. The expected loss from shirking is thus 10% of the difference between the efficiency wage ($8,000) and the industry wage ($3,000), which is 10% of $5,000 = $500. Therefore, to make the worker indifferent between working and shirking, the reservation wage must be $500.

A Firm Uses an Efficiency Wage Scheme to Deter Workers