Problem Set 4
6-7. The 2006 U.S. Statistical Abstract shows that, among all 25-34 year-olds, the average
annual earnings of a high school graduate with no further education was $26,073 while the
average annual earnings of a college graduate with no further education was $43,794 is 2003.
(a) Assuming college requires five years, show that the annual return to each year of college
education averages 10.9%.
(b) It is typically thought that this type of calculation of the returns to schooling is biased,
because it doesn’t take into account innate ability (i.e., ability in the workplace not due to
college) or innate motivation. If this criticism is true, is the actual return to each year of a
college education more than or less than 10.9%?
6-8. Suppose there are two types of persons: high-ability and low-ability. A particular diploma
costs a high-ability person $8,000 and costs a low-ability person $20,000. Firms wish to use
education as a screening device where they intend to pay $25,000 to workers without a diploma
and $K to those with a diploma. In what range must K be to make this an effective screening
device?