Question 1:
Now, consider a case with the following assumptions:
θ = 0.05 (i.e. 5% rather than 50%).
Let the other values be the same as in the previous questions:
wh=40,000, wl=20,000, c=15,000, σh=3,000, and σl=10,000.
Explain why it is an equilibrium under these assumptions for:
• the high-ability workers to earn the degree and be paid $40,000, and
• the low-ability workers to not earn the degree and be paid $20,000
In other words, explain why:
• High-ability workers will want to earn the degree; Low-ability workers will not want to earn the degree; Employers will want to pay higher wages to people who earn the degree – they will want to pay $40,000 to workers who hold the degree and $20,000 to people who do not.
Question 2:
Finally, make all the same assumptions as in the previous question, but assume that the government prohibits the practice of paying higher wages to people who earn the degree. If all workers need to be paid the same wage, what wage will be paid? Would this government policy enhance the efficiency of the economy? Would it constitute a Pareto improvement? Explain.