Question

1) Suppose there are two types of economics majors, “stars” and “everyone else” and both types would

like jobs at a consulting company. Productivity equals $100,000 for the stars, and $50,000 for everyone

else. 80 percent of economics majors are "everyone else” (meaning not stars) and 20% are stars.

Suppose none of the screening methods consulting companies use are effective. However, workers may

signal their ability by earning an MBA at an elite business school. The cost is 30,000 for the stars, and

60,000 for everyone else. All firms pay workers their productivity (if there is signaling), or their expected

productivity (if there is no signaling). Workers are employed for only a single period after being hired.

a. How is it possible that the cost of an MBA differs by ability? Tippie’s website advertises

in-state tuition at Iowa for the full-time MBA program as $40,000 and does not

distinguish between ability.

b. Is the MBA an effective signal? Discuss the three criteria.

c. Now suppose the population is evenly divided between stars and ‘everyone else’. Does

this change your answer to (b)?

d. Discuss your results to (b) and (c). Intuitively, why does the percent of the population

that is a star impact whether getting an MBA is a beneficial choice for a star?

2) Suppose the consulting company is trying to create a job offer so that only stars will apply. The firm

plans to create a probationary period during which time new hires earn $X. After an evaluation period, it

will promote the stars and pay them $Y. It will let go of everyone else. The probationary period is 1 year

and candidates who are promoted will stay for 1 additional year. Assume all applicants can easily get a

job for $60,000 at other firms.

In order for the offer to induce signaling, suggest a value for X and a value for Y. (Do not worry about the

firm maximizing profit, just focus on the signal generating a separating equilibrium.)

In order for the above job offer to induce signaling, what assumptions are we implicitly making? Why

might low quality candidates accept the job offer? Why might high quality candidates not accept the offers?

Answer 1