Question

Assume that the cost of doing a 4 year programme is given by £60k per year for a lov ability individual, and £30k per year for a hig ability individual. Managers find it hard to distinguish which workers are high or low ability, so they pay them the same salary of £250k ( the avg value of output per worker). However, if they earn the diploma from the 4 year programme, the workers will get paid £380k.

1. Should the people deemed as 'high ability' or 'low ability' employees complete the programme?
2. If the cost fell to £40k per year for a 'low ability' employee, should they do the programme? Does having this serve as an effective signal

Answer 1

High ability individuals should definitely complete the 4-year program as they can recover the cost in less than a year. For low ability individuals, the program may not be as beneficial unless the cost falls to £40k per year, in which case it would be beneficial and serve as an effective signal of ability. Option 2 is correct answer.

Step-by-step explanation:

The question asks whether individuals classified as 'high ability' or 'low ability' should complete a 4-year educational program based on the costs of the program and the potential salary increase upon completion. Additionally, it questions whether the reduction of the program's cost for 'low ability' individuals would change the cost-benefit analysis and whether having the diploma serves as an effective signal of ability.

For high ability individuals, the cost of the program is £30k per year for 4 years, amounting to £120k in total. With a diploma, they will be paid £380k, which is £130k more than the average salary without the diploma (£250k). Hence, they recover the cost of the program in less than one year. Therefore, it is beneficial for high ability individuals to complete the program.

For low ability individuals, the cost is £60k per year, totaling £240k for 4 years. Post-program, they would earn £380k. In this case, the cost of education is close to the first year additional earnings (£130k), suggesting a longer period to recoup the investment. Considering that the cost is nearly equivalent to the additional income for the first year, it may not be immediately beneficial for low ability individuals to undertake the program especially when taking into account the time value of money and opportunity costs.

If the cost fell to £40k per year for low ability individuals, totalling £160k over 4 years, and they are paid £380k after earning their diploma, they would see a benefit. The total cost is now significantly lower than the additional earnings, marking the program as potentially beneficial for low ability individuals and serving as an effective signal to employers since it would still indicate a higher potential productivity.