ECON2232 Economics of Human Resources
Tutorial 12 (Self-Study)
Fall 2024
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Tutorial Exercises
2018-2019 Section B Question 1
Solution.
(a) It could be the case that the large-firms workers and the small-firm workers are systematically different—
usually large-firm workers are more ambitious and outgoing, but such characters are not measurable.
One way to test this explanation is to track a group of labor who switched from a large firm to a small
firm—the treatement group. Check the difference in their wages before and after. Use the group of
labor who stayed in the large company and had the same observable labor quality and other similar
controls as the control group. This group should belong to the same cohort as the job switchers before
they quit. We then calculate the difference in difference (DiD) in wages:
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Before
After
Difference
Treatment Group
$x
$y
$ (y − x)
Control Group
$x
$z
$ (z − x)
DiD
$ (y − z)
If there is no significant drop in wage for switchers (treatment group) relative to their peers who stayed
in the large companies (control group), i.e. $ (y − z) ≈ 0, then the hypothesis that “the size of the
firm has a causal effect on the wage paid to its employees” can be rejected. The logic hinges on the
assumption that the unmeasured dimensions of labor quality of the switchers should not have changed
within a short period.
A limitiation of this method is that there could be a selection bias—those switchers switched from a
large to a small firm, possibly, for example, because they are very capable in terms of some unmeasured
quality such that they receive competitive promotional offer from the small firms.
(b) If this hypothesis is true, the quit rates should be low in both types of firms. In equilibrium, this
wage differential should be such that no worker nor firm could find a different combination of wage and
working environment to get better off. If there is no systematic change in wages and working conditions
in the two types of firms, the quit rates should stay low in both types of firms and hence be roughly
the same.
(c) Suppose working hard makes it more probable to result in a good output level and shirking makes it
more probable to result in a bad output level. If the wage that the worker would get upon a realization
of good output level is very high relative to the wage he would get in case of a bad output level, he
would be incentivized to work harder to achieve a better output level and avoid a bad output realization.
Since workers are motivated to work hard and have less incentive to shirk, monitoring can be reduced.
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