Suppose 10% of all workers are of high ability. If a firm knows a worker's ability, workers of low ability are paid $20,000 and workers of high ability are paid $30,000. A college degree can signal ability, and the cost of the degree is $11,000. Will there be a pooling equilibrium or a separating equilibrium?
What will be an ideal response?
Under a pooling equilibrium, all workers are paid (0.1 ? 30,000 ) + (0.9 ? 20,000 ) = $21,000. The high-ability worker must pay $11,000 to gain $9,000. She will not; so, a pooling equilibrium is possible. Under a separating equilibrium, the high-ability worker must pay $11,000 to gain $10,000. She will not; so, a separating equilibrium is not possible.
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