question archive A company does not know whether workers on an assembly line work hard or whether they slack off
A company does not know whether workers on an assembly line work hard or whether they slack off
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A company does not know whether workers on an assembly line work hard or whether they slack off. A solution for this situation is to pay the workers "piece rates," that is, pay them according to how much they have produced each day. All workers are risk-averse, but the company is not risk-neutral. Which of the following statements is true?
A. This is a situation of moral hazard; the company does not know how much effort a worker expends.
B. This is a situation of adverse selection; the company does not know how much effort a worker expends.
C. This situation involves neither adverse selection nor moral hazard.
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The correct answer is: B. This is a situation of adverse selection; the company does not know how much effort a worker expends.
Moral hazard is slightly different from adverse selection. While a lack of information brings about adverse selection, moral hazard is brought about by the provision of misleading information, then altering behavior after a transaction has been completed with the intention of gaining maximum benefits from the transaction.
In this situation, the factory does not have information about the performance of an employee during work hours. The factory, therefore, lacks sufficient information to determine how much money to pay the worker. Piece-rates eliminate this problem by providing the employer with information about the employee's performance.
