Assume there are 2 types of workers: high-ability workers, and low-ability worke
ID: 1214040 • Letter: A
Question
Assume there are 2 types of workers: high-ability workers, and low-ability workers. The proportion of workers that are high-ability is (“theta”), so the proportion that are low-ability is (1-). Over their career, the value of the output produced by a high-ability workers is wh. The value of the output produced by a low-ability worker is w.
Assume that wh > w.
Assume that the market for labor is perfectly competitive.
If employers can observe which workers are high-ability and which workers are low-ability, how much will high-ability workers be paid over the course of their career? How much will low-ability workers be paid? Explain.
Explain the following: If employers cannot tell which workers are high-ability and which workers are low-ability, a risk-neutral employer with the objective of maximizing expected profit will pay all workers the same, and the wage that they pay will be:
wo = wh + (1-)w
Explanation / Answer
Question 1
The case with perfectly competitive market ascertains perfect symmetry of information where principals have full knowledge of the hidden qualities of its agents. Assume there are 2 types of workers: high-ability workers with a proportion of , and low-ability workers with (1-). The value of the output produced by a high-ability workers is wh and the value of the output produced by a low-ability worker is w. Clearly, wh > w.
A high-ability workers be paid a salary that is equal to the market value of the output produced by them. Since it is given that this value is wh for and the value of a high-ability workers and w by a low-ability worker, a low-ability worker will be paid w while a high-ability worker will be paid wh. Overall the cost of wages incurred by the employer is wh* to all high ability workers and w*(1-) to all the low-ability workers
Question 2
When there is asymmetric information and the employers cannot tell which workers are high-ability and which workers are low-ability, a risk-neutral employer with the objective of maximizing expected profit will pay all workers the expected wage rate which is given by
E(w) = Wage to high-ability worker*Its proportion + Wage to low-ability worker*Its proportion
= wh + (1-)w
= wh* + w*(1-)