COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 1544R

Grading in Games of Status: Marking Exams and Setting Wages

Pradeep Dubey and John Geanakoplos

December 2005
Revised January 2006

We introduce grading into games of status. Each player chooses effort, producing a stochastic output or score. Utilities depend on the ranking of all the scores. By clustering scores into grades, the ranking is coarsened, and the incentives to work are changed.

We first apply games of status to grading exams. Our main conclusion is that if students care primarily about their status (relative rank) in class, they are often best motivated to work not by revealing their exact numerical exam scores (100,99,...,1), but instead by clumping them into coarse categories (A,B,C).

When student abilities are disparate, the optimal grading scheme is always coarse. Furthermore, it awards fewer A's than there are alpha-quality students, creating small elites. When students are homogeneous, we characterize optimal grading schemes in terms of the stochastic dominance between student performances (when they shirk or work) on subintervals of scores, showing again why coarse grading may be advantageous.

In both the disparate case and the homogeneous case, we prove that absolute grading is better than grading on a curve, provided student scores are independent.

We next bring games of money and status to bear on the optimal wage schedule: workers can be motivated not merely by the purchasing power of wages, but also by the status higher wages confer. How should the employer combine both incentive devices to generate an optimal pay schedule?

When workers' abilities are disparate, the optimal wage schedule creates different grades than we found with status incentives alone. The very top type should be motivated solely by money, with enormous salaries going to a tiny elite. Furthermore, if the population of workers diminishes as we go up the ability ladder and their disutility for work does not fall as fast, then the optimal wage schedule exhibits increasing wage differentials, despite the linearity in production.

When workers are homogeneous, the same status grades are optimal as we found with status incentives alone. A bonus is paid only to scores in the top status grade.

Keywords: Status, Grading, Incentives, Education, Exams, Wages

JEL Classification: C70, I20, I30