5 3 Asymmetric information (answers)

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Microeconomics II 
Undergraduate degree in Economics 
 
Review exercises – 5.3. Asymmetric information 
 
Exercise 37.2. from Bergstrom and Varian’s book (2006) “Workouts in Intermediate 
Microeconomics”, pp. 442-443 
 
In West Bend, Indiana, there are two kinds of workers. One kind has a (constant) 
marginal productivity worth $10 and the other kind has a (constant) marginal 
productivity worth $15. There are equal numbers of workers of each kind. A firm 
cannot directly tell the difference between the two kinds of workers. Even after it has 
hired them, it won’t be able to monitor their work closely enough to determine which 
workers are of which type. 
a) If the labor market is competitive, will the workers be paid the average value 
of their marginal productivity? How much will they earn? 
b) Suppose that the local community college offers a microeconomics course in 
night school, taught by Professor M. De Sade. The high productivity workers 
think that taking this course is just as bad as a $3 wage cut, and the low-
productivity workers think it is just as bad as a $6 wage cut. The firm can 
observe whether or not an individual takes the microeconomics course. 
Suppose that the high-productivity workers all choose to take the 
microeconomics course and the low-productivity workers all choose not to. 
What will be the competitive wage for people who take the microeconomics 
course? And for those who don’t? 
c) If there is a separating equilibrium with high-productivity workers taking the 
course and low-productivity workers not taking it, what will be the net 
benefits from taking the course for the high-productivity workers? And for 
the low-productivity workers? Will there be a separating equilibrium of this 
type? 
d) Suppose that Professor De Sade was called to Washington to lecture 
congressmen on the economics of family values. His substitute is Professor 
Morton Kremepuff which prides himself on his ability to make economics 
“as easy as political science and as fun as the soaps on TV.” Professor 
Kremepuff’s claims are exaggerated, but at least students like him better than 
De Sade. High-productivity workers think that taking Kremepuff’s course is 
as bad as a $1 wage cut, and low-productivity workers think that taking 
Kremepuff’s course is as bad as a $4 wage cut. If the high-productivity 
workers all choose to take the microeconomics course and the low-
productivity workers all choose not to, what will be the wages for those that 
took the course and for those that didn’t take the course? 
e) If there is a separating equilibrium with high-productivity workers taking the 
course and low-productivity workers not taking it, what will be the net 
benefits from taking Kremepuff’s microeconomics course for the high-
productivity workers? And for the low-productivity workers? Will this kind 
of separating equilibrium exist? 
 
Microeconomics II 
Undergraduate degree in Economics 
 
Answers: 
 
a) $12.5 
 
b) 
Competitive equilibrium wage for the people who took the course in Microeconomics: 
$15. 
Competitive equilibrium wage for the people who didn’t took the course in 
Microeconomics: $10 
 
c) 
Value of the net benefits from taking the Microeconomics course for the higher 
productivity type of workers: 15 - 10 – 3 = $2 
Value of the net benefits from taking the Microeconomics course for the lower 
productivity type of workers: 15 - 10 – 6 = -$1 
The separating equilibrium exists because it pays the most productive workers to attend 
the course while for the less productive type it does not. 
d) 
Competitive equilibrium wage for the people who took the course in Microeconomics: 
$15. 
Competitive equilibrium wage for the people who didn’t took the course in 
Microeconomics: $10 
 
e) 
Value of the net benefits from taking the Microeconomics course for the higher 
productive type of workers: 15 - 10 – 1 = $4 
Value of the net benefits from taking the Microeconomics course for the lower 
productive type of workers 15 - 10 – 4 = $1 
This type of separating equilibrium does not exist, since it would pay to attend the 
course for all the workers. If everyone did, the company would no longer be able to 
distinguish the productivity between the two types of workers and would pay $12.5 for 
everyone. In this case, it does not pay the more productive workers to attend the course 
in Microeconomics, because they would not be able to signal their higher productivity. 
 
Note: Apparently the most productive workers can differentiate only with the 
maintenance of Prof. De Sade and Prof. Kremepuff would hardly have students, 
although they like him more, but we must remember that this exercise assumes that the 
only effect of Microeconomics classes is signaling the existing productivity and not 
increasing the productivity of those who attend the course …