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 (H) at 12,000 GBP per month and a low-ability worker (L) at 6,000 GBP per month. The supply of high-ability workers is QHS = 0.05(W - 2,000) and the supply of low-ability workers is QLS=0.1(W - 2,000), where W 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

If workers ability is observable,

Equilibrium wage of high ability workers=12000

Qh*=0.05(12000-2000)=0.05*10,000=500

Workers surplus=1/2*500*(12,000-2000)=250*10,000=2.5 million

Equilibrium wage of low ability workers=6000

QL*=0.1(6000-2000)=0.1*4000=400

Workers surplus=1/2*400*(6000-2000)=200*4000=800,000

Total surplus=3.3 million

If workers ability is not observable,then all workers will get same wage equal to 6000 ( low ability worker wage).

Qh*=0.05(6000-2000)=0.05*4000=200

Surplus=1/2*200*(6000-2000)=100*4000=400,000

Employers benefit due to lower wage given to high ability=6000*200=1,200,000

QL*=0.1(6000-2000)=400

Surplus= same as before.=800,0000

Deadweight loss= 3.3-0.4 M-1.2M-0.8M=1.1M=1,100,000