Question

A.  Assume Charlie lives for two periods and must choose between two options.  Option 1:  Do not attend school at all and work in both periods at a salary of $20,000 per period.  Option 2:  Attend school in the first period incurring $5,000 in direct schooling costs, then in the second period work at a salary of $45,000.  Assume the discount rate between periods is 5 %.  Which option will Charlie choose to pursue?

B.  State whether the below is True or False, then explain your reasoning.

When a worker’s non-labor income increases, the substitution effect on leisure hours is negative, the income effect on leisure hours is positive, and hence the change in hours worked is ambiguous.

C.  Draw the age-earnings profile for a typical worker in the United States. Explain why it is shaped the way it is.

Answer 1

A.

In option 1: The total slary that Charlie will be earning throughout his life time is

Period1 income + Period2 income = $40,000

Option 2 : In period1, his earnings are negative as he will have to bear the cost of education.

Given the discount rate of 5%, the present value of the icome earrned in future will become = 45,000/(1+0.05) = $42,857. And over this he will have to bear the education cost too.

With bearing the cost of schooling, he will have to bear the opportunity cost of not working in period1 i.e. $20,000. and over that he will have to wait for 1 period to be able earn which is halff of his life as he will be alive for only 2 periods.

Thus, looking at the above case scenerios, Charlie would choose option 1 and earn in both periods getting more satisfaction and more earnings.

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