Louise works for BabySoft, a small software company producing computer games for
ID: 1168900 • Letter: L
Question
Louise works for BabySoft, a small software company producing computer games for very young children. In designing its software, BabySoft uses a particular kind of program (let's call it D-) that is very idiosyncratic; basically no one else uses it any more. Unfortunately, much of BabySoft's own internal code is written in D . Louise does not know D and is deciding whether to learn it. To do so would cost her the equivalent of $50,000 in psychic and time costs this year. If Louise learned D-, the expected present value of her lifetime output at BabySoft next year would increase by $80,000. To keep matters simple, assume Louise will only stay at BabySoft for a total of two years (this year and next) and the discount rate is zero. Because BabySoft is a small startup, wage setting is informal. This year's wage is already fixed. At the start of next year, Louise will meet with the CEO to bargain over her wage. The end result is that her wage next year will split the difference between what she is worth to the company and what she can earn elsewhere. In this situation, will Louise decide to learn D--? Why or why not? What if learning D-- raised next year's output by $110,000? Does your answer depend on the sharing rule (i.e. on the expected outcome of her bargaining meeting with the CEO)? Is the company better off if Louise learns D--? Can you think of a better way for BabySoft to run its wage (and/or training) policy than in (a)? (We are looking for a "win-win", or Pareto-improving policy that makes both the company and Louise better off than if the training did not occur). If so, describe it. If possible, devise a scheme that induces Louise to make the "correct", i.e. the Pareto-optimal, training decision regardless of the parameter values, i.e. regardless of the costs of learning D-- or the actual effects of knowing on her productivity.
Explanation / Answer
a.
Cost to learn=$50000
P.V of increase in output=$80000
Her wage next year =Her worth to company-Cost of learning=80000-50000=30000
Since she is going to leave in the company for 1 more year, thus in the span of 2 years her cost of learning of 50000 will be more than her lifetime income of 30000. It is loss for Louise so will decide not to learn.
Case: Output raises by $110000 next year
Then her wage next year =Her worth to company-Cost of learning=110000-50000=60000
Now her life time earnings of $60000 will be more than her learning cost of $50000. Now she can decide to learn the D--
Yes the company will better off it the Louse learn D--.
b.
The best policy as on now would be to give wage atleast equivalent to the learning cost in the first year. Since the case clearly depicts that Louise will leave the firm in 2 years. However the company needs to things from long term perspective and expected future income in long terms. If the company provides wage of equivalent to learning cost the it will be breakeven for Louise for learning D— if she stays for 2 years only but iif she stays more than 2 years it will be net profit for Louise.
For the firm she leaves exactly in 2 years, it will be loss to firm but if she continue more than 2 years, it will be profir to firm.
Alternatively, firm can bear the training and learning cost and provide the wage to Louise depending on the profit
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