1. Consider the following market in which workers can either be of high (H) or low (L) productivity. The outside option for both workers is 2. The productivity of L workers in the market is 2 and the productivity of H workers is 6. There are many firms in this market and they behave competitively.

Potential employers cannot observe the productivity of a worker ex ante, but they can verify the level of education a worker has received. The L workers have a utility function of UL = wL - eL, where wL is the wage their receive and eL is their level of education. The H workers have a utility function of UH = wH - eH, where wH is the wage they receive and eH is the education attainment.

Outline a separating equilibrium in which employers can distinguish between low- and high-type workers. Use a diagram to help in your explanation as to how this equilibrium works. What if the H-type workers have an outside option of 5.5 - what would happen in that case?