Question

You need to hire some new employees to staff your startup venture. You know that potential employees are distributed throughout the population as follows, but you can't distinguish among them: Employee Value Probability 0.125 $40,000 $59,000 0.125 $78,000 0.125 $97,000 0.125 $116,000 0.125 $135,000 0.125 $154,000 0.125 $173.000 0.125 The expected value of hiring one employee is Suppose you set the salary f the position equal to the expected value an employee. Assume that employees will not work for a salary below their employee value. The expected value of an employee who would apply for the position, at this salary, is Given this adverse selection, your most reasonable salary offer (that ensures you do not lose money) is

Answer 1

The expected value of hiring one employee is given as:

p(r) 0.125*40000+0.125*59000+0.125*78000+ Expected value 0.125 97000 0.125 116000 0.125 135000 0.125 154000 0.125173000 0.125 852000= 106500

Now employer sets the salary of the position as expected value = $106500.

Employees who have a higher value than the salary will decide not to apply for this position.

Then, expected value of an employee who will be applying to the position:

ΣΡα employee EV<106500 Expected value of an 0.125 40000 0.125 59000 0.125 780000.125 97000 =34250

Hence expected value of an employee who would apply for the job at a salary of $106500 is $34250.

Given this adverse selection, most reasonable salary offer (that ensures you do not lose money) is $34250. But since this is less than employee value of all the employees, no one would accept the job offer.

Hence owing to adverse selection, equilibrium salary is $0 and no worker is hired for the job.