Suppose a firm hires workers from a large pool of

Suppose a firm hires workers from a large pool of potential employees. Suppose further that
workers come in two types, productive and unproductive, and that half the workers in the
population are of each type. Each productive worker hired by the firm will generate $80,000
of revenue per year for the firm, while each unproductive worker will generate $40,000 of
revenue per year for the firm.
Each worker knows his own type. Also, each worker could choose not to work for the
firm, and instead generate an alternate income by being self-employed. Workers who are
more productive will get more value from being self-employed: suppose that each productive
worker could produce an income of $55,000 per year through self-employment, while each
unproductive worker could produce an income of $25,000 per year through self-employment.
So if the firm could accurately determine the type of each job applicant, the situation would
be straightforward: the firm could o ↵ er a salary between $55,000 and $80,000 to each pro-
ductive applicant, and a salary between $25,000 and $40,000 to each unproductive applicant,
all job o ↵ ers would be accepted, and both workers and the firm would benefit from each job
that is taken at the firm.
Unfortunately for the firm, it cannot reliably determine the type of each worker. So the
firm has to o ↵ er a uniform wage of w , and simply hire workers who are willing to work at
wage w . The firm is willing to o ↵ er a given wage w if and only if the average revenue it
receives from the workers it hires at this wage is at least w .

716 CHAPTER 22. MARKETS AND INFORMATION
Equilibria in the Labor Market. In our example, what wages can be o ↵ ered, and which
workers will be willing to work for the firm? The reasoning is very similar to the case of used
cars. We start by looking for a self-fulfilling expectations equilibrium. If the firm expects all
workers to be on the job market, then — since there are equal numbers of the two types of
workers — its expected revenue per employee will be
80 , 000 + 40 , 000
2
= 60 , 000 ,
and hence it can o ↵ er a uniform wage of $60,000 per year. At this wage, both types of
workers will be willing to accept the firm’s o ↵ ers, and so the expectation will be confirmed
by what happens — we have an equilibrium in which all workers are hired.
By analogy with the used-car example, there is also another — less socially desirable —
equilibrium. If the firm expects only unproductive workers to be on the job market, then
it expects to make only $40,000 per year per employee, and so this is the maximum wage
it will o ↵ er. At this wage, only unproductive workers will be willing to accept jobs, and
so again the firm’s expectations are confirmed. So there are two possible equilibria here —
a high one and a low one, with di ↵ erent mixtures of workers in the applicant pool in the
two equilibria. Essentially, the firm’s a priori level of confidence in the quality of its job
applicants is self-fulfilling.