Question #3. Consider the possibility that employers take the degree to be a rel
ID: 1214042 • Letter: Q
Question
Question #3.
Consider the possibility that employers take the degree to be a reliable signal that a worker is a high-ability worker. Given this belief, employers pay workers $wh if they have the degree and $w if they do not. Let high-ability workers be twice as productive as low-ability workers, with wh=40,000 and w=20,000.
Let c=15,000. Let h=3,000 and =10,000.
Given all these assumptions, who will choose to get the degree? Will it be an equilibrium for firms to pay wh to workers with the degree and w to workers without the degree? Explain.
Remember: “equilibrium” means no tendency for change. To show that something is an equilibrium in this model, you must show that no one would want to change their behavior. Will low-ability workers want to change their decision about whether or not to get the degree? Will high-ability workers want to change their decision? Will employers want to change their decision about paying $wh to workers with the degree and $w to workers without the degree?
Let “c” be exogenous. In other words, do not worry about whether “the school” would want to change the level of tuition that it charges.
Question 4.
Return to the situation in Q3: Employers consider education to be a reliable signal about whether or not a worker is of high-ability, and “the school” is exogenous (i.e. “the school” is not part of society).
Answer the following questions under the assumptions in Q3:
From a high-ability worker’s point of view, does it make sense to earn the degree?
From society’s point of view, does it make sense for high-ability workers to earn the degree?
From society’s point of view, would efficiency be enhanced by a government prohibition on paying higher wages to people who earned the degree? Would such a prohibition be a Pareto improvement?
Explain.
Explanation / Answer
Education is a valuable investment in human capital and it helps in generating the productivity of labor. Before entering into the labor market, one expects every additional year to increment the earnings as a student will learn new skills and knowledge. Completion of education signals employers that the student is of high ability and integrity. He is capable of new competencies that are required in employment. He has a great potential to be a productive employee or worker. Some are the able students to complete higher education as it brings lots of costs with it to complete. Completion of higher education does not mean that the student is the most productive employee, however, his education help employers to determine most productive and reliable job candidates. Thus, education serves as signal of ability. Greater education leads to higher earnings even if it does not add anything to productivity.
Now, we assume that there are two types of workers. The one with high ability and the other with low ability. Both the types are equal in numbers. Now, there are two equilibriums: pooling equilibrium and separating equilibrium.
In separating equilibrium, the low-ability workers do not want to go for higher education. They obtain minimum amount of education. On contrary, high-ability worker want to invest in education. The employers determine the level of wage on the basis of signal they receive. They pay a wage which is equivalent to the low type's ability with no education and pay a wage which is equivalent to high type's ability in case of education as a signal.
In pooling equilibrium, both the low-ability and high-ability workers do not want to invest in higher education. Both the workers choose same level of education regardless of ability. The employer offers wages which is equivalent to the expected value of worker's ability.
Education correlates with social outcomes. But, schooling has no relation with worker's productivity. The purpose of education is simply to make students confident that they can achieve anything if they are willing to do. Role of schools and colleges is a signal rather than determinant of ability. Education takes a lot of money and is unproductive, thus, every student will receive only the minimum level of schooling required by law, i.e. 10 years.
According to the economists, the most efficient equilibrium is the separating equilibrium, all others are unstable. However, signaling equilibrium is often inefficient. It is the government intervention that might improve the allocation of resources. If the government is perfectly informed about the worker's ability, it could be easily resolved the issue. The government can improve the allocation of resources by introducing pooling equilibrium. The government can compel pooling by banning education beyond 10 years. However, in reality, education plays a significant role in assessing a high salary job. Thus, this policy of banning education must not exist.