Chapter 1: Setting Hiring Standards

Question 1

When hiring risky workers, the option value is higher when…?

Answer 1

• the riskier the candidate
• the downside is smaller
• the upside potential is higher

Question 2

When is the downside of hiring a risky worker smaller?

Answer 2

• the cost of poor performance is small
• termination costs are low

Question 3

When is the upside of hiring a risky worker higher?

Answer 3

• the potential profits the candidate can bring are huge (ex, creative jobs with high upside potential)

Question 4

When hiring risky workers, the option value is affected by…?

Answer 4

• Length of evaluation
• Length of employment
• Level of risk aversion

Question 5

Why does the length of the evaluation affect the option value of hiring a risky worker?

Answer 5

the quicker the true performance of the risky worker can be determined, the higher the value

Question 6

Why does the length of employment affect the option value of hiring a risky worker?

Answer 6

the longer the job tenure, the higher the value

Question 7

How can firms continue gaining benefits from risky hires when they turn out to be stars since their market value (eventually rises)?

Answer 7

Firms can still make profits from the stars by offering a pay level lower than their productivity

Question 8

Considering risky workers that are stars, why can firms offer a pay level lower than their productivity

Answer 8

• switching jobs is costly to workers
• stars are not easily identified by competitors
• productivity is firm-specific

Question 9

In practice, managers are often reluctant to hire risky candidates…why?

Answer 9

If managers were to hire a risky worker who turns out to be a lemon then their reputation would look bad

Question 10

What is cost-effectiveness?

Answer 10

Cheap labor is not low-cost labor

Question 11

In reality, productivity isn’t always independent, why?

Answer 11

• productivity is independent of coworkers
• productivity depends on coworkers
• productivity depends on capital

Question 12

What does it mean when productivity is independent of coworkers?

Answer 12

Choosing the lowest cost per unit of output

Question 13

What does it mean when productivity depends on coworkers?

Answer 13

The number of HS and college grads depend on each other

Question 14

What does it mean when productivity depends on capital?

Answer 14

The optimal level of skill rises as the use of capital relative to labor increases

Question 15

What is marginal product of Labor?

Answer 15

The change in output resulting from hiring an additional worker, holding constant the quantities of all other inputs; the slope of the total product curve

Question 16

What are diminishing returns?

Answer 16

as more and more workers are added to a fixed capital stock, the gains from specialization decline and the marginal product of workers decline

Question 17

When are profits maximized?

Answer 17

When the value of the marginal product of labor equals the wage rate