Butch and Bucky live for 2 periods each. In the first period, they can choose to
ID: 1209054 • Letter: B
Question
Butch and Bucky live for 2 periods each. In the first period, they can choose to go to school or work. In the second period, they work. There are no direct costs to schooling (i.e. no tuition) and no inflation (i.e. all earnings are in real terms). If Butch does not go to school, he earns $5 in both periods. If he goes to school, he earns $0 in period 1 and $15 in period 2. If Bucky does not go to school, he earns $4 in both periods. If he goes to school, he earns $0 in period 1 and $10 in period 2. Both Butch and Bucky want to maximize their present value of earnings over their (short) lives. Any first-period earnings are not discounted, and all second-period earnings are discounted by 1 + r, where r is the discount rate. 1. Write the present value of earnings of Butch's earnings if he goes to school (since I have not yet given you the value of r, just leave the present value in terms of a general r). Then write the present value of Butch's earnings if he does not go to school. 2. Write the present value of earnings of Butch's earnings if he goes to school (since I have not yet given you the value of r, just leave the present value in terms of a general r). Then write the present value of Butch's earnings if he does not go to school. 3. What is Butch's internal rate of return (i.e. at what interest rate is he indifferent between schooling and no schooling)? What is Bucky's internal rate of return? 4. Suppose both guys are pretty impatient such that r = 0.75 (or 3/4) for both of them. Which guy(s) will go to school? 5. A politician in this world knows nothing about Butch and Bucky, but he does observe that those who go to school earn $15 in period 2 and those who do not go to school earn $4 in period 2. As a result, he is advocating ways to encourage everyone to go to school under the assumption that it will increase the earnings of those who are currently not going to school from $4 to $15. Based on the information in this problem, discuss why the politician's logic is flawed.Explanation / Answer
Human Capital: human capial is basically, the stock of knowledge, skills, attitude, personality traits embodied in an individual which can be used to perform the jobs in various fields. In other words, the human beings available for doing jobs with their stock of skills, knowledge attitude (which can be developed) act as a human capital for the individuals.
People going to school will be able to earn more at a later point of time but in their period 1 they will not be earning anything so their even with the discounting rate their earning remains zero while the ones not going to school will start earning from day 1 (although a lesser amount). So, from the individual's viewpoint, it depends upon their family condition whether they can wait for higher earnings at a later point of time & invest their time in developing the skills of Butch & Bucky kind of people by going to school or they need to earn on an urgent basis from day 1 itself.
From the Economy point of view, individuals going to school will be required for Blue collar jobs but at the same time, economy needs skilled workforce also. for white collar jobs or skill based jobs also, people should be groomed but with different type of skills.
The politician in the above case, is looking only at the money generation by the individuals going to school Vs. the money generated by the people not going to school. The politician need to look at the broader perspective of skill requirement, knowledge requirement & the workforce requirement at different levels & in different fields.
Also, for money generation, if we use the discounting rate as given in the question to calculate the present value of the money generated in future, it will give lesser present value for the people generating money in period 2 & going to school in period 1 as compared to people not going to school at all & generating money from period 1 itself
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