Efficiency

Efficiency:

In a separating equilibrium an education is privately useful for high ability workers, but since we assume that it doesn’t affect productivity, it is socially inefficient compared to the perfect information case. With a perfectly competitive labor market, firms just break-even in all cases; low ability workers are paid less, high ability workers more. However, it is possible that both types of workers are worse off. This could occur if there is a separating equilibrium in the middle region of figure below. Even though they receive a higher gross wage, their net wage wh−c, could be less than the pooling wage, ‾w. Nonetheless, if one high ability worker signals, all must signal in order to avoid being seen as a low ability worker (wh−c > wl, but wh−c < ‾w). In this case, high ability workers would helped by a ban on higher education! However, in the region in which only a separating equilibrium is possible, they do not want such a ban ((wh− c > wl, and wh − c > ‾w).

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