SUMMARY ON EDUCATION AS SIGNALLING
ibrium (H and L worker are employed at same wage)
Empirical analysis by
. is positive.
the
Empirical analysis by A. Weiss (1988): The effect of education on worker's productivity may not be significant for workers performing the same task.
There is also a " "
which is felt and most relevant in fast-changing environments. Educated workers are better equipped than non educated workers to adapt to new and unexpected occurrences, like change in job content due to technological
progress. Alla these aspects are absracted from when education is taken to only a signal.
reservation wage equal for H and L
consider the full information contract first.
net surplus for Principal net surplus for worker type H
type L
By fixing the wage equal to the reservation wage, the Principal can get the entire social surplus.
IN INSURANCE MARKET
p'(a) < 0
higher maintenance cause lower probability of damage
insurance company considers the 'standard' value of maintenance expenditure and fixes a 'fair' premium
In this way the agent in case of damage will suffer a loss. Because the is exposed to risk (cannot fully ensure against damage), to the extent that she is risk-averse, she has an incentive to carry out the maintenance expenditures that can reduce the probability of damage. The deductible D must be so fixed that post-contract opportunistic behaviour is non attractive. Thus the amount D must fulfill the incentive-compatibility constraint.
by observing output y, the principal P can know what effort x has been performed by the agent
A = agent P = principal
x* = optimum effort for P
the agent A must find effort x* more attractive than any other effort level x. A spontaneously chooses x*
The following contracts meet the above constraints if y =f(x) is deterministic
K = fixed wage component
A's incentive compatibility constraint is fulfilled
(3)
Hidden action
If the relation is not deterministic, the same effort x may be associated to a high or low output. There is no way for Principal to check what effort x has been produced by A, but by direct monitoring.
Wage contract:
If monitoring is very costly, the possibility that the agent adopts post‐
contact opportunistic behavior will arise in contracts such as the wage contract, in which the payment to A depends on time spent at work
(possibly resting) not on effort. Now fixing ∗ ∗ is not sufficient to make sure that the worker chooses ∗. Now the wage contract does not give rise to the maximum social surplus, hence it is not Pareto
efficient.
Rent contract:
Also the rent contract is not Pareto efficient, but for different reason.
Because the agent A is the residual claimant, she has an incentive to maximize the difference . The problem is however that production is now a risky activity (output is volatile), and the entire risk under the rent contract is taken by the agent A. If the principal P is richer than the agent, it is likely (as we have seen) that A is more risk averse than P. The rent contract is not Pareto efficient because it gives rise to a non efficient division of risk between P and A . It leaves all the risk with the more risk‐averse agent.