Participants in labor market experiments are aware that the experiments run for a limited amount of time. Thus behavior during a temporary experiment will be different than if the experimental change in constraints confronting participants were permanent. In evaluating changes in policy, however, the response to permanent changes is of primary interest. The paper analyzes conditions under which permanent responses can be inferred from data on temporary experiments.

We present a model of firm behavior in which firms choose a wage and a hiring standard to maximize their profits. The correlation between productivity and reservation wage affects the relationship among firm size, wages, and hiring standards. In the special case where labor productivity is a linear function of a worker's reservation wage, we find that in the absence of hiring costs wages are monotonically increasing with firm size. Any positive hiring costs, however, result in an interval of sufficiently small firms within which wages decrease with firm size. In all cases, among sufficiently large firms, wages increase with firm size. A review of previous empirical evidence finds that in some occupations the relationship between wages and firm size is U-shaped, while in other occupations wages increase monotonically with firm size. These empirical findings are consistent with our theoretical results.

Contests are situations in which an individual's reward depends on his performance relative to others. Students are graded on a curve; the candidate with the most votes gets the political office; the underling who performs best is promoted to the executive position. Contests are useful in dealing with indivisible rewards, reducing monitoring costs, and minimizing risks from common uncertainties. They are employed to sort potential participants and, once they have entered, to induce appropriate effort from them. With monitoring precision and prize spreads as potential choice variables, optimal contest structures are derived for fair and unfair contests among equal and unequal participants. The converse problems of climbing-low-ability individuals enter the contest designed for high-ability candidates-and slumming are shown to be manageable.