Problem
Debbie has just finished high school and is about to decide which type of education to get. She has narrowed down her options to two alternatives. She can either become a marine biologist or a concert pianist. Suppose that Debbie lives two periods. In the first, she gets an education. In the second, she works in the labor market. If Debbie becomes a marine biologist, she will spend $15,000 on tuition and books. She will then earn $472,000 in the second period. If she becomes a concert pianist, it will cost her $40,000 in the first period, but she will earn $500,000 in the second period.
a. Suppose Debbie can lend and borrow money at a 5 percent rate of interest. Which career will she pursue? What if she can lend and borrow money at a 15 percent rate of interest? Will she choose a different option? Why?
b. Suppose that musical conservatories raise their tuition, so that it now costs Debbie $60,000 to become a concert pianist. What career will Debbie pursue if the discount rate is 5 percent?