Answer to Question #269148 in Economics for Raman

Question

Recently, the owner of a Trader Joe’s franchise decided to change how she compensated her top manager. Last year, she paid him a fixed salary of $65,000 and her store made $130,000 in profits (not counting payment to her top manager). She suspected the store could do much better and feared the fixed salary was causing her top manager to shirk on the job. Therefore, this year she decided to offer him a fixed salary of $35,000 plus 16% of the store’s profits. Since the change, the store is performing much better, and she forecasts profits this year to be $270,000 (again, not counting the payment to her top manager). 

 

Assuming the change in compensation is the reason for the increased profits, and that the forecast is accurate, how much more money will the owner make (net of payment to her top manager) because of this change?

 

$ 

 

Does the manager make more money under the new payment scheme?

Answer 1

The new salary is:

$35,000 + 0.16×270,000 = 78,200.$

The change in profits is 270,000 - 130,000 = 140,000.

As $78,200 > $65,000, then the manager makes more money under the new payment scheme.