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Midterm 2Practice Problems 3
I. High School Choice
Degree (HS) or drop out (No).
Two types of individuals, Type 1=rate (r1)
increase, Type 2= (r2); where r1>r2.
Given a base earnings B, PV1 HS=B(1+r1) PV 2 HS=B(1+r2),
PV No=B,
cost=C no matter the worker type.
B=100, r1=0.35, r2=0.2, C=22
1.) Optimal schooling choice both types
: PV HS=B(1+r1)C , PV HS=B(1+r2)C
PV1 HS=100(1+.35)=135 , PV 2 HS=100(1+.2)=120, PV No=100 [TA did not take Cost
out]
T1=13522=113, T2=12022=98, T No=100
[With Cost taken out]
[Earnings do not involve cost in this
problem]
PV HS=(1+r) B=B+Br ; PV No HS=B ;
r= PV HSPV No HS
= 135100
=.35
PV No HS
100
3.) Gov. gives cash prize P=3, HS incentive to graduate, is this sufficient?
Yes, b/c now if Type 2
receives P=3, cost=(223)=19
EarningsCost=12019=101
No School=100; Type 1 always goes to school, Type 2>100 =goes to school
4.) Market perf. comp. & earnings reflect productivity. Social returns= earningscosts.
Is prize
desirable from social planner view?
No, in terms of signaling model, education is wasteful &
individuals overinvest in it. Prize artificially increases returns to education and makes
people invest more into a wasteful activity. In HC model, undesirable b/c person makes
optimal choice given costs & returns to education. Prize viewed as a transfer & not real
return to education.
II. Onthejob training
:
2period problem, Training takes full period, Untrained=MPL^NT=100 for
all firms if train=MPL
⇓
10%; Trained=30%>Untrained; Training costs=10 in 1
st
period; Future
period r=.05; Output P=1 both periods; Pay worker W nt=100 both periods. Trained=WT1 in 1st and
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 Spring '08
 LENTZ

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