1. List the key sources of heterogeneity amongst employees and employers, then discuss how asymmetric information makes hiring a complex process. 2. What are the key insights of the Roy model of self-selection for employers and workers? 3. (Roy model). Consider a simple economy with two occupations: law (L) and medicine (M), and a large number of workers. Workers' ability is described by pairs (, u), where > is talent as lawyer and u as doctor. Pairs (u) are uniformly distributed over 0 < < Lo and 0 Mo. (i.e. each pair is equally represented in the population). The market rewards legal skills at the rate = $5, and medical skills at the rate m = $10 (assume Lo = 12, Mo = 20 so exLo = 60 < mxMo= 200). (a) What are the average legal and medical abilities in the population at large? What are average earnings if everybody picks his occupations randomly? (b) Who chooses law and who chooses medicine? (Note: in the knife-edge case assume workers choose law). What are the average earnings of lawyers? How do they compare with the answer in (a)? (c) What is the effect of a small increase in the value of m upon occupational sorting? Provide a graphical representation. 4. Workers know their abilities, but employers do not. The respective productivities of high- and low-ability workers are a = $150 and a = $80; education has no effect on productivity. Because of the extra work involved, an engineering degree costs high-ability workers $50 and low-ability workers $80 relative to a degree in advanced flower pressing. Can high-ability workers use an engineering degree to signal their abilities to employers? Work-out the step- wise procedure to determine the equilibrium. What would happen if it cost low-ability workers only $60 to take engineering?