Suppose a firm hires a worker under a legally binding two-period contract. The c

Question

Suppose a firm hires a worker under a legally binding two-period contract. The contract specifies that worker will be paid $1500 in period 0 and $4000 in period 1. The worker has a MPL (in either period) of $1500 if the firm does not offer any training program for the worker. If the firm makes a training program available in period 0, the MPL of the worker will be $5000 in period 1.

What is the highest cost of the training program, Z, such that a profit-maximizing firm will choose to train the worker in period 0?

What is the highest cost of the training program, Z, such that a profit-maximizing firm will earn positive profits from this contract? Assume the firm uses a discount rate of 10 percent.

Explanation / Answer

Cost of firm when it offers no training = 1500+4000

Cost of firms when it offers training = 1500+1500+4000 = 7000 (i.e. workers will not work in period 0 and the wage paid in both periods )

Profit without training = MPL - Cost = 3000 - 5500 = -2500

Profit with training = 5000 -7000 = -2000

So, the highest cost of training program = 1500 (MPL in period 0)

Now the highest cost with discount factor are = (1+0.1)*1500 = 1.1*(1500) = 1650

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