Economic Perspectives IV

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Relative Vs. Absolute Incentives

Thus far, the simulations have given us a closer look at two of the pieces in the overall puzzle. First we explored the mechanisms of information's influence on productivity on the level of an individual agent. Then we looked at its impact on an entire organization. The next hypothesis takes us one step further, bringing another theme into the picture - agent incentives:

Hypothesis 4: Absolute incentives encourage information sharing, which promotes group productivity; relative incentives discourage information sharing, but promote individual productivity. The optimal incentive policy in terms of productivity becomes increasingly absolute with increasing task interdependence.

"Why Information Should Influence Productivity" supports this hypothesis with the following anecdotal evidence:

"The intuition follows from a classroom grading example: under an absolute incentive scheme, every student who scores 90 percent or higher gets an "A." One successful student does not displace another but group study can lower individual effort. Under a relative scheme, the top 10 percent of the students get an "A" regardless of the actual score. Students are ranked relative to one another and may work hard to beat out other students. Assuming self-interested behavior, the former policy promotes sharing, while the later discourages it."

For a more mathematical argument in favor of hypothesis 4, see the corresponding mathematical appendix at the very end of this tutorial. In the rest of the slides, we presume the proposition's truthfulness, and go on to explore some of its implications for a network of agents.

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