Consider a simplified version of the data described above. Shelly decided study economics and now is about to choose the school. She has narrowed her options to two alternatives. She can either go to Purdue or the University of Chicago. Shelly lives two periods. In the first, she gets an education. In the second, she works in the labor market.
If Shelly attends Purdue, she will spend $15,000 on education in the first period and earn $472,000 in the second period. If she attends the University of Chicago, she will spend $40,000 on education in the first period and then earn $500,000 in the second period.
a. Suppose Shelly can lend and borrow money at a 5 percent annual rate. Which school will she choose?
b. What if she can lend and borrow money at a 15 percent rate of interest? Will she choose a different option? Why?
c. Suppose the University of Chicago raise their tuition so that it now costs Shelly $60,000 to attend. Which school will Shelly pursue if her discount rate is 5 percent?