Question

4. Mina and Tina are siblings who live in two periods (t=0,1) and face identical opportunities. They can either work in a job that requires no education and pays $30,000 in each period, or they can earn $90,000 in period 1 after pursuing education in period 0 at a cost of $20,000.

a. If Tina’s per-period discount rate is 0.25, what will she choose to do?

b. If Mina’s per-period discount rate is 0.05, what will she choose to do?

c. Based on his views on the education-health relationship, which sister would Victor Fuchs expect to be healthier?

Answer 1

a

No education present value of two period earnings is:

First period value = 30,000

Second period value:

Present value of money:	=	FV/ (1+r) ^N
Future value	FV=	$               30,000
Rate of interest	r=	25%
Number of years	N=	1
Present value	=	30000/ (1+0.25)^1
	=	$         24,000.00

Total present value is 54,000

Tina's present value of earnings is:

Present value of money:	=	FV/ (1+r) ^N
Future value	FV=	$               90,000
Rate of interest	r=	25%
Number of years	N=	1
Present value	=	90000/ (1+0.25)^1
	=	$         72,000.00

Net present value = 72,000-20,000 = 52,000

Tina will not opt for education, as present value is less than that of not having education.

b

Present value of money:	=	FV/ (1+r) ^N
Future value	FV=	$               90,000
Rate of interest	r=	5%
Number of years	N=	1
Present value	=	90000/ (1+0.05)^1
	=	$         85,714.29
Less cost		20000
NPV		$         65,714.29

Mina will go for education

c

Study has better impact on health than not having. So Mina will be healthier.