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If the cost of search is €3, and wages are uniformly distributed between €20 and €50, what is the smallest wage you need to be offered for you to accept it and stop searching if you are risk-neutral? Multiple Choice €36.58. Correct €50. €20. €17.21.

Answer

The smallest wage you need to be offered to accept it and stop searching if you are risk-neutral is €36.58. This is calculated by subtracting the cost of searching (€3) from the maximum wage (€50), which gives €47. Then, this is divided by the difference between the maximum and minimum wages (€30) which gives €1.57. Finally, this is multiplied by the minimum wage (€20) to give €36.58.

Explanation

To calculate the smallest wage you need to be offered to accept it and stop searching if you are risk-neutral, you need to take the maximum wage and subtract the cost of searching. This gives the maximum benefit from searching. Then, this figure needs to be divided by the difference between the maximum and minimum wages to work out the incremental benefit of searching. Finally, this figure is multiplied by the minimum wage to work out the smallest wage you need to be offered to accept it and stop searching if you are risk-neutral.

Example

In this example, the maximum wage is €50, the cost of searching is €3 and the difference between the maximum and minimum wages is €30. Therefore, the maximum benefit from searching is €47 (€50 – €3). This is then divided by the difference between the maximum and minimum wages, which gives €1.57. This is then multiplied by the minimum wage of €20, giving €36.58 as the smallest wage you need to be offered to accept it and stop searching if you are risk-neutral.

Calculation

The calculation for the smallest wage you need to be offered to accept it and stop searching if you are risk-neutral is as follows:

Maximum wage – Cost of searching = Maximum benefit from searching

Maximum benefit from searching ÷ Difference between maximum and minimum wages = Incremental benefit of searching

Incremental benefit of searching x Minimum wage = Smallest wage you need to be offered to accept it and stop searching if you are risk-neutral

Related Questions

What is the maximum benefit from searching in this example?
What is the incremental benefit of searching?
What is the difference between the maximum and minimum wages?
What is the cost of searching?
What is the minimum wage?
What is the maximum wage?
What is the smallest wage you need to accept if you are risk-averse?
What is the smallest wage you need to accept if you are risk-seeking?
What is the maximum wage you need to accept if you are risk-neutral?
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