A good salesperson can sell 1,000,000 worth of goods, while a ...

[deesands]

A good salesperson can sell 1,000,000 worth of goods, while a poor one can sell only 100,000 worth of goods. Job applicants know if they are good or bad, but the firm does not. A firm will offer job applicants a choice between a fixed salary of 25,000 or 20 commission. Assuming risk-neutral salespersons and the possibility of opportunistic behavior, will this choice of contracts allow the firm to distinguish between good salespersons and bad ones before the hiring decision is made?
 
  What will be an ideal response?

Question 2

A good salesperson can sell 1,000,000 worth of goods, while a poor one can sell only 100,000 worth of goods. Job applicants know if they are good or bad, but the firm does not. A firm will offer job applicants a choice between a fixed salary and 20 commission. Assuming risk-neutral salespersons and no opportunistic behavior, what level must the fixed salary be so that the firm can distinguish a prospective good salesperson from a poor one, and thereby avoid hiring a poor one?
 
  What will be an ideal response?

[raili21]

Answer to Question 1

Under commission, a good salesperson will earn 200,000 and a poor salesperson will earn 20,000. A fixed salary that is above 20,000 but less than 200,000 would be preferred only by poor salespersons. The 25,000 will work at screening out poor salespersons as long as the income that bad salespersons could earn elsewhere is at least 20,000, but less than 25,000. If the poor salesperson's opportunity cost of working for this firm is less than 20,000, he might accept the commission plan just to send the false signal that he is a good salesperson, and, therefore, be hired.

Answer to Question 2

Under commission, a good salesperson will earn 200,000 and a poor salesperson will earn 20,000. A fixed salary that is above 20,000 but less than 200,000 would be preferred only by poor salespersons.