Problem Set 4

Problem 1
Consider a rm deciding which job to assign to a worker. The worker's ability can be high

or low (H or L) with equal probability, and the jobs can require high or low ability (H or L).

Part (a)

Suppose initially that both the worker and the rm get a payo of 2 when the worker is

matched to the corresponding job and 0 when mismatched. If the worker can send a costless

message m ∈ {H, L} to the rm, what is the best equilibrium outcome? What are the

payos to each type of worker and what are the payos to the rm in this equilibrium?

Part (b)

Now suppose that the worker gets a raise of 3 when he gets the job H. Moreover, it is more

costly to the rm to assign a low worker to the high-ability task than vice verse. Payos are

as follows, with the the worker's type in the row, the job type as the column, worker's payo

as the rst number listed and rm's payo as the second number listed:

job type H job type L

worker type H 5, 2 0,0

worker type L 3, −1 2, 2

If the worker can send a costless message m ∈ {H, L} to the rm, what will be the equilibrium

outcome? What are the payos to each type of worker and what are the payos to the rm?

Part (c)

[Note: this is a dicult question, anticipating week 9 material.]

Now, keeping the payos same as in part (b), suppose the message H costs x to the low skill
worker and x/2 to the high skill worker. What value of x maximizes the payos that the high
type worker can earn in equilibrium? What value of x maximizes the payos that the low

type of worker can earn in equilibrium? What value of x maximizes the average payos that

the worker can earn in equilibrium?

1
Problem 2
A rm's has quality θ ∈ {0, ..., 100}, each of which is equally likely. Regardless of θ, with
1 9
probability
10
, the rm can only send message m=∅ while with probability
10
it can send

one of two messages m=∅ or m = θ. Consumer observes the rm's message and forms a

belief about the rm's expected quality b = E [θ|m]. The rm wants to maximize b, i.e., it

wants to maximize the consumer's expectation of its quality.

Note the distinction between 0, which is a potential value that θ can take and ∅, which is

not a potential value for θ but rather a message that is silent about θ.
Is there an equilibrium with a cuto type θ∗ such that: (i) every rm with θ < θ∗ sends a

message m = ∅, (ii) every rm with θ ≥ θ∗ sends a message m=θ if it can? If so, what is
∗
θ ?

[Note: this problem may be too dicult to solve on pen and paper. You will receive full

credit even if you use software to solve it as long as you clearly describe what you did.]