Page 426 - DECO401_MICROECONOMIC_THEORY_ENGLISH

Unit-30: Economics of Information

This way, the moral hazard and the implementation of warranty, prevent the pooling equilibrium of Notes
good and bad cars. This is the reason they are conjugated together in the market.

Market Signalling

To solve the problem of adverse selection and moral hazard, Michael Spence, a famous Nobel Economist,
has suggested the Market Signalling. He showed when information is asymmetric; signalling creates
the information about features of men in job market. The concept is that the applicants are signalling
all information about their qualifications for a particular employment to the employer. According to
Spence, a signal is given by education and the employer considers a test of original qualification of
degree. They mean more productive and pay high salary for the applicants who have high level of
education. The other side, they mean less productive and pay salary for the applicants who have low
level of education. This way the education is signal of productivity.
To describe the signalling, Spence developed a model of market-employment. Which is based on the
education of the applicant.

Self Assessment

State whether the following statements are True/False:
7. A little change in reservation price can reduce the expected purchasing cost.
8. The reservation price, number of searches and that cost of purchasing depend on the searching cost
per unit.
9. When one party has more information than the other, then it creats the problem of favourable
selection.

10. Economist and economic analyst have studied the practice of price in the stock market.

Assumptions

This model is based on the following facts:
1. The level of education and productivity is positively co-related.
2. The college and institution can lost more cheaply the productivity than the employer.
3. High qualified is mean that low cost of education.

The Model

Having such perceptions, suppose that an employer finds groups of people searching the job in the
competitive labour market. Group-1 labour has low productivity. Their maximum production is 1.
They don’t have college degree. And Group-II, has degree, their maximum production is 2; because
there is difference in the level of education.
Spence measures the level of education and a composite index of year which is shown as Y. A man
has the cost of education Y in group-I and Y/2 in group-II. It means that cost of education having
low productivity has more than the cost of education having high productivity. Suppose, C = y is the
1
cost of education for group-1 and C = y/2 is the cost of education for group-II. If C Y is 60,000 then
2
1
C = Y/2 30,000. Now, suppose that the employer decides the expected productivity 50,000 by giving
2
the employment for their life time of the group and 1,00,000 for the men of group-II productivity.
Identifying the both types of people for the job, the employer proposed the wage schedule. w (y) of
w d = 50,000 for group-I and w 1,00,000 for group-II for their life time.
1 2

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