Quiz 11: Incentive Pay

Business

The workers are likely to sort their work according to their abilities. Higher ability workers prefer to work with firm 'B' considering that it offers piece-rate compensation system. Workers 1 to 34 opt for firm 'A' considering that the time rate offered by the firm is greater than their value of marginal productivity. A decrease in demand for the output produced by the workers leads to reduce the wages paid to them. If the both firms 'A' and 'B' are likely to reduce the wages then the sorting of the workers remain unchanged. More productive workers find no incentives to work with firm 'A' due to reduction in its wages. Therefore if the wages in both the firms reduces by half, then the workers are not likely to change their firms. They would prefer to remain in the same firm.

In a price-rate system, workers are given compensation according to the number of units of output produced by them. Produced output by the workers is taken into the account while determining the compensation. In terms of time-rate system, workers are given compensation according to the number of hours worked by them. The number of working hours is taken into the account while determining the compensation in time-rate system. Following are the factors which are considered while determining whether to offer a piece-rate or a time-rate compensation system. 1. Productivity of workers. Firms prefer to offer time-rate compensation system if the productivity of labor is relatively higher. If the productivity of workers is lower, then firms would prefer to offer piece-rate compensation system. 2. Monitoring cost. Monitoring cost of workers plays an important role while determining whether to offer a piece-rate or time-rate compensation system. If the monitoring cost is relatively higher, then the firms would prefer to offer a time-rate compensation system. 3. Measurement of produced output. If the output produced by the workers is difficult to measure, then the firms prefer to offer a time-rate compensation system. If the output is easy to measure, then the piece-rate system would be preferred. 4. Profitability. The firms offer a system which maximizes their overall profitability. If the piece-rate system leads to maximize the profit, then the firms are likely to offer it to the workers. Thus, Productivity of the workers, monitoring cost, ease of measuring workers' produced output, and profitability are the factors which determine whether to offer a piece-rate or time-rate compensation system.

The rental compensation system developed in the taxicab industry due to the monitoring problems. The owners of the taxicabs find it difficult to monitor revenue earned by the taxicab drivers. There is possibility that the drivers might not inform correctly about the generated revenue. Misinformation from the taxicab drivers leads to reduce the profitability of the taxicab owners. Thus, considering reduction in the profitability occurred due to monitoring problems, taxicab owners have developed a rental compensation system.