George and Laura can choose between two career options, janitor or school teache

ID: 1099407 • Letter: G

Question

George and Laura can choose between two career options, janitor or school teacher. If George chooses to be a janitor, he will earn $15,000 per year. If he chooses to be a school teacher, he has to go to school full-time the first year and he will earn $30,000 as a school teacher the following year. Laura can earn $20,000 per year as a janitor. If she decides to be a school teacher, she has to go to school full-time the first year and she will earn $45,000 the following year. There are two periods, there is no direct cost of schooling and the discount rate is 10 percent.
a) Calculate the present value of life-time earnings for George for each option. Will George go to school?
b) Calculate the present value of life-time earnings for Laura for each option. Will Laura go to school?
c) Would the cross-sectional estimate of the returns to schooling (comparing George

c. For George PV if choosing no school = 28636

For George PV if choosing school = 27273

True returns to education for George = 27273/28636 - 1 = -4.76%

For Laura PV if choosing no school = 38182

For George PV if choosing school = 40909

True returns to education for Laura = 40909/38182 - 1 = 7.14%

Cross Sectional return = Sum of PV if choosing school / Sum of PV if not choosing school - 1

= (27273 + 40909)/(38182 + 28636) - 1 = 68182/66818 - 1 = 2.04%

As 2.04% > True returns to education for George = -4.76%, it is overestimated for George.

As 2.04% < True returns to education for Laura = 7.14%, it is underestimated for Laura.

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