Setting the Parameters of the Soviet Incentive System In the former Soviet Union a central planning authority controlled production in the manufacturing enterprises. In order to plan and coordinate aggregate production in the economy, the central planning authority requires forecasts from the enterprise managers about the production possibilities during the upcoming planning period. At first, managers were rewarded based on their ability to live up to production quotas that were, for the most part, based on the production forecasts of the managers themselves.

In response to evidence that enterprise managers built slack into forecasts of production possibilities, a new Soviet Incentive Plan was implemented. This plan provided a means of eliminating slack from forecasts by changing the basis of the rewards received by the enterprise managers.

The details of this plan were discussed in the chapter.

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Required (1) Explain why the ranking of the order of the three parameters of the Soviet Incentive model is important. (2) What relationship must exist among the three parameters of the incentive equation of the Soviet Incentive model in order to motivate the manager to set a planned target that equals the manager's expectation of the mean value of production? (3) In applying the scheme, the central planners committed to changing the parameters of the incentive plan only every five years. Why is this characteristic important, and how would the properties of the incentive scheme be changed if the parameters of the incen- tive scheme were changed annually? What implications does this observation have for target setting in participative budgeting schemes in general? (4) Explain how the properties of the Soviet Incentive model would change if managers were risk-averse. (This question requires the use of differential calculus and a basic knowledge of the properties of utility theory.)