Question

5. Doogie lives for four periods. He has just completed the first period of his life (by getting his

high school diploma). Doogie is trying to decide on his future career path. He’s very good at

opening things up and fixing them, so he has narrowed his options to two possible paths. He will

either become an auto mechanic or a brain surgeon.

•If Doogie becomes an auto mechanic, he will earn $25,000 as an apprentice in

period 2, $50,000 as a solo mechanic in period 3, and $75,000 as a master

mechanic (with apprentice) in

period 4.

•If Doogie becomes a brain surgeon, he will pay $50,000 to attend college in

period 2, another $75,000 to attend medical school in period 3, and will earn

$300,000 in period 4.

Doogie must make all tuition payments at the beginning of each period, he is paid at the end of

every period, and he can borrow and lend at a rate of 8% per period.

a. What is the present discounted value (PDV) of Doogie’s possible career paths? If Doogie wants to maximize the PDV of his lifetime earnings, which career should he choose?

b. Would Doogie’s choice change if he was making his decision at birth? Would the PDV (present discounted value) of his earnings streams be different at birth? Would Doogie’s evaluation of this investment change if he started life with a trust fund of $1 million? Explain. (Assume that Doogie’s high school education in period 1 is necessary for both career paths and is costless.)

c. How would your answer change if Doogie could work for an additional 10 periods after period 4? How would your answer change if the discount rate decreased? (Answer intuitively in terms of whether the surgery track becomes relatively more or less attractive).

d. The actual lifetime earnings of brain surgeons are much higher than those of auto mechanics, yet we observe that the number of auto mechanics is much greater than the number of brain surgeons. How can the human capital model explain these patterns?

Answer 1

A. The present discounted value of Doogie in case of Auto Mehcanic is $105,447.69 and in case of Brain Surgeon is $83,217.17. So as per the cashflow of 4 periods Doogie should choose Auto Mechanic as career path of he wants to maximise his earnings.

B. The choice would not change even if this decision was made at Birth. The PDV at Birth would be $97,636.75 for Auto Mechanic and $81,136.44 for Brain Surgeon. The decision would not change even if Doogie started with $1 mln as the Present value of trust would remain same in both the cases.

C. If Doogie could work for additional 10 periods after period 4 then Brain Surgeon career path would be more monetarily rewarding. As the interest rates were to be reduced, Auto Mechanic career would start to become less and less attractive and Brain Surgeon career would start to look more and more promising.

D. As per human capital model improved education of workforce is seen as an investment that will lead to an increased economic return and higher productivity to individuals. This explains why Brain surgeon earns more in their lifetime than Auto Mechanic. However education involves cost during initial years and does not payoff unless we start working. Whereas taking of job soon after school starts rewarding right from day one and does not entail any cost. Thus generally people trade off long term pleasure for short term gain, hence we see no. of Auto Mechanics are much more than that of Brain Surgeon.