Question

Consider the "Offer Matching Policy" game described in Lecture 5, but simplify the problem to just 1 year, rather than 30.

Suppose that:

• The employee has an outside offer to work for $27 per hour, for 1500 hours per year
• The employee currently works for $20 per hour, for 2000 hours per year
• The switching cost can be either high ($1'000) or low ($50)
• The high switching cost has probability 40%; the low switching cost 60%

What is the value of the new offer for the employee? (note: there is nothing to discount since we have just 1 period

Answer 1

Current annual earnings of employee = Earning per hour * No of hours worked in a year

= $20 * 2000 hours

= $ 40,000

Earnings of the employee under new offer = Earning per hour * No of hours worked in the year

= $27 * 1500 hours

= $ 40,500

Switching cost to employee = (Probability of high cost * High cost ) + (Probability of low cost * Low cost)

= ($ 1000 * 40%) + ($50 * 60%)

= $400 + $ 30

= $ 430

Value of the new offer for the employee = Earnings of employee under new offer - Existing earnings of the employee - Swtiching cost

= $40,500 - $40,000 - $430

= $70

Hence value of new offer = $70