Suppose 10% of all workers are of high ability. If a firm knows a work

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?

ANSWER

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.