I'm taking a course on game theory and am faced with this prompt. What's most rational?
Person X is due for a raise at her company. Her company is offering her two options:
Option A is to continue receiving the same salary and stay within the bonus pool.
Option B is to increase her salary to match her bonus amount last year, but opt out of the bonus pool moving forward. Her bonus last year was $30,000. Therefore, her new salary would be $30,000 more than what it was.
The track rate of previous bonus pools are unknown.
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I think the most rational way to approach this is by looking at each option's worst case scenario and to take the one with the least worst. Option A's worst case scenario is there's no bonus and player X receives no extra money. Option B's worst case scenario is player X still earns $30,000 more.
The thing that's holding me up is the potentially infinite reward Option A gives because the bonus pool is not capped. How much should that option be considered, if any at all, since the past performance of the bonus pool is an unknown?
The correct way is to calculate the expected value. Since there is little data, the expected value is equal at base +30.000. The expected volatility is zero in case A and unknown but not zero in case B so a risk averse person would gain some utility out of going A.
Note however as both options are not a raise as the expected value is equal to her current salary and if person X accepts, she will be highlighted as an example of wage discrimination against women.
Expected value is not necessarily the way to go. I would rather be paid 100k Currency Units per year than a 50% chance of 210k Currency Units and a 50% chance of zero. Expected utility is more to the point.
Note also that part of the (dis)utility of unpredictable compensation comes from things other than the actual monetary value. You might find it exciting not knowing what's coming. Or you might find it anxiety-provoking. If it's a bonus scheme, you might take some satisfaction in the feeling that if your hard work helps the company succeed then you will g... (read more)
I'm taking a course on game theory and am faced with this prompt. What's most rational?
Person X is due for a raise at her company. Her company is offering her two options:
Option A is to continue receiving the same salary and stay within the bonus pool.
Option B is to increase her salary to match her bonus amount last year, but opt out of the bonus pool moving forward. Her bonus last year was $30,000. Therefore, her new salary would be $30,000 more than what it was.
The track rate of previous bonus pools are unknown.
—
I think the most rational way to approach this is by looking at each option's worst case scenario and to take the one with the least worst. Option A's worst case scenario is there's no bonus and player X receives no extra money. Option B's worst case scenario is player X still earns $30,000 more.
The thing that's holding me up is the potentially infinite reward Option A gives because the bonus pool is not capped. How much should that option be considered, if any at all, since the past performance of the bonus pool is an unknown?