Question 1: Suppose the standards of the school are lowered so that earning the

Question

Question 1:

Suppose the standards of the school are lowered so that earning the degree no longer entails psychic costs for anyone. The cost of earning the degree is now purely monetary ($c) and the same for both high-ability and low-ability workers. If c=15,000 and employers pay wh = $40,000 to people with degrees and w = $20,000 to people without degrees, who will decide to earn the degree? Who will decide not to earn the degree? Assume that =0.5.

Question 2:

Under the assumptions of the previous question, would it be an equilibrium for employers to pay wh = $40,000 to people with degrees and w = $20,000 to people without degrees? Explain.

Explanation / Answer

Expected total pay = 0.5(40,000) + 0.5(20000) = 30000

cost of earning degree for high ability = 15000

cost of earning for low ability = 15000

total cost = 30000

Therefore, there is an equilibrium.

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