Economists and psychologist have long wondered how worker effort relates to wages. Specifically, the question is whether worker effort responds to increased wages alone or whether effort also responds to relative wages.
(a) Design a classroom experiment that would allow you to quantify the relationship between effort, reward, and relative reward.
(b) Explain how the data you collect can be used to identify both relationships. What do you think you would find?
(c) Suppose a consulting firm intends to estimate the following regression for a firm:
outputi = β0 + β1wagei + β2relwagei,
where outputi is worker i's hourly production, wagei is worker i's hourly wage and relwagei is the ratio of worker i's wage to the publicly known average wage at the firm. How can the results of the regression be used to determine the importance of wage levels and relative wages in the production process?