There are two types of worker, high ability and low ability. High-ability workers generate gross profit of A on the job and low-ability generate nothing. Education does not make workers more productive, but is costly to obtain (cH for high ability workers and cL for low ability ones). Let w be the wage that all firms in the economy pay by regulatory mandate. Suppose the worker obtains utility given by the wage (if the worker is employed, 0 if not) minus the cost of education (if any). There is no disutility from work. Which condition is required if only the high-ability type is to obtain an education in equilibrium?
a. cH < w < cL.
b. cL < w < cH.
c. cH < cL < w.
d. cL < cH < w.
Question 2
Return to the situation with the executive from the previous question. Now assume that shareholders cannot observe effort, so cannot specify how hard the executive works in the contract but must induce it through the incentive scheme. Which of the following wage contracts would work out best for shareholders in equilibrium?
a. A flat wage w = 2,500 with no profit share.
b. A share of 35 of the gross profits.
c. A share of 55 of the gross profits.
d. A share of 70 of the gross profits.
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