Question

1.1 Each entry-level Economics undergraduate in Glasgow, Scotland, has either high or low ability. All potential employers value a high-ability worker at £18,000 per month and a low-ability worker at £9,000 per month. The supply of high-ability workers is ?? ? = 0.05(? − 2,000) and the supply of low-ability workers is ?? ? = 0.1(? − 2,000), where ? is the monthly wage.

If workers’ abilities are observable to employers, what are the equilibrium wages? How many workers of each type do employers hire? If employers do not observe workers’ abilities, what is the equilibrium wage? How many workers of each type do employers hire? What is the deadweight loss due to asymmetric information?

Answer 1

Since the attribute of the workers are visible, so the wages will be as per the valuation of the worker. So the high quality workers will have a wage of £18000 and the low quality workers will have a wage of £9000.

For High quality Workers,

?? ? = 0.05(? − 2,000) = 0.05 * (18000-2000) = 800

For Low quality Workers,

?? ? = 0.1(? − 2,000) = 0.1 * (9000 - 2000) = 700

So the firm will hire 800 high quality workers and 700 low quality workers.

If the attributes are not visible, then we see that at any particular wage, the low skilled workers are double that of the high skilled workers from their demand equations.

So the equilibrium price can be determined in the ratio of these workers. So equilibrium wage = 18000 * 1/3 + 9000 * 2/3 = 12000

The deadweight loss is given as 1/2 * (difference in number of high quality workers at high price and equilibrium price) * (Difference of High price and Equilibrium price)

High quality workers at equilibrium price = 0.05(? − 2,000) = 0.05*(12000-2000) = 500

= 1/2 * (800 - 500) * (18000 - 12000) = 1/2 * 300 * 6000 = 900,000

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