University of North Carolina Economics 190, Oertel, Fall   Midterm Exam 2     November 4, 2002

 

Part A: Multiple Choice

1c, 2b, 3c, 4b, 5c, 6c, 7c, 8d, 9c, 10d, 11a, 12d, 13b

 

Part B: Essay Questions/Problems

 

1. Earnings tend to increase with education. 

a) [4 points] What is the human capital interpretation of this?  Explain.

 

The human capital interpretation is that “education increases productivity”.  Schooling, in this view, teaches tangible skills.

 

b) [4 points] What is the ‘signaling’ interpretation?  Explain. 

 

“Education only reveals productivity”.  According to this view, schooling may not teach anything, but only the smartest make it though college.  Those with more education are still more productive, but they were more productive in the first place. 

 

c) [4 points] Economists think that finding evidence in favor of one or the other of these explanations should matter for education policy.  Why?  Explain?

 

Well, if “signaling” were the true explanation for why earnings increase with education, then making education cheaper (through government policy) would only lead to inflation in educational credentials.  These kinds of subsidies would then be a waste of public money and an unproductive attempt to fight poverty.  If human capital were the true explanation, then education can effectively raise people’s earnings capacity, and this kind of spending can be worthwhile.  

 

2. Economists believe that on-the-job training (OJT) is a good (partial) explanation for the fact that earnings increase with experience. 

a) [6 points] Economists also believe that firm and worker will share the cost of specific OJT.  Why?

 

With specific OJT, a worker acquires skills that are not portable- the skills are only useful at the current employer.  The worker would not undertake such an investment alone because she does not know that she would be retained.  The firm would not undertake such an investment alone because it does not know whether the worker will stick around.  Each faces a potential loss because the other might leave.  If there is any investment in specific OJT, it will involve both paying for some. 

[What payoff structure would make it happen?  The 2nd period wage must exceed any available alternative. Then the worker would stay, and knowing that, the firm is willing to chip in.  The 2nd period wage must also be  less then the 2nd period VMP.  Then the firm would want to hang on to the worker, and knowing that, the worker is willing to chip in.]

 

b) [4 points] What is an alternative explanation for the relationship between earnings and experience?  Explain.

 

With a delayed-compensation contract, earnings would also rise with experience.  This type of contract would be introduced to reduce ‘shirking’ and increase effort in settings where individual day-to-day output is difficult to measure.

Employees are underpaid early on and overpaid later.  Workers work more diligently to ensure being around for the period of overpayment.

 

3. Suppose that the marginal revenue from search is given by MR= 70 – 4w, where w is the wage offer at hand.  The marginal cost of search is given by MC=10+2w.

a) [3 points] Why is marginal revenue from search a negative function of the wage offer at hand?  Explain.

 

MR depends on the probability of getting a better offer (having rejected the current offer).  This probability is smaller if the current wage offer is high.

 

b) [3 points] Why is the marginal cost of search a positive function of the wage offer at hand?  Explain.  Can you give an interpretation of the intercept?

 

Rejecting an offer means forgoing that income.  This is the opportunity cost of continuing the job search.  Hence the positive slope.  The intercept in the MC expression (10) says that there is a cost to performing a search even if there is no wage offer (w=0).  So the intercept must represent the direct cost of searching.

 

c) [3 points] What is the worker’s asking wage?  Will this worker accept a job offer of $8?

 

Solve for the w that makes 70-4w=10+2w.  This asking wage is $10.  A wage offer of $8 would be rejected.

 

d) [3 points] Suppose UI benefits are reduced, and the marginal cost of search becomes MC=10+4w.  What is the new asking wage?  Will this worker accept a job offer of $8?

 

Now find the w that makes 70-4w=10+4w.  This asking wage is $7.50.  A wage offer of $8 would be accepted.