Grant, a young Newfoundlander, has just graduated from high school and is deciding what to do with the rest of his life, which lasts two periods (like everyone else's). His main decision is whether to stay in Newfoundland or migrate to Toronto. If he stays in Newfoundland, he will earn Y0 in period 1 and Y1 in period 2. If he moves to Toronto, he will incur a moving cost of M (in the first period), and he will be unemployed (with zero earrings) for the first period. In his second period in Toronto, he will earn YT. The interest rate at which money can be borrowed or invested is T.

1. On a carefully labeled diagram, illustrate Grant's migration decision; that is, show his earnings paths as a function of time, depending on whether he lives in Newfoundland or Toronto.

If he stays in Newfoundland, earning will be Y0+r*Y0+Y1= (1+r)Y0+Y1

If he moves to Toronto, earning will be YT - M - rM= YT - (1+r)M

2 . Show that he will move to Toronto if (YT - Y1) > (1+r)(Y0+M)

What is the economic intuition underlying this result? How does an increase in the interest rate affect the migration decision? Why?

(YT - Y1) > (1+r)(Y0+M) can be modified like YT - (1+r)M > Y1+ (1+r)Y0.

So, it means that the NPV of moving to Toronto is higher than staying in Newfoundland.

If the interest rate increases, the NPV of staying in Newfoundland will be higher because Y0 that he made in the first period will be more lucrative and it will be more costly to go migrate to Toronto. ( - (1+r)M will be larger, and (1+r)Y0 will also larger)

3 As a potential labour economist, Grant realizes that he needs to have estimates of YT and Y1 in order to make a wise migration decision. He reads in the newspaper that the average earnings of Newfoundlanders in Toronto are YT, while Newfoundlanders earn an average of Y1 if they stay in Newfoundland. (Both magnitudes refer to second-period earnings) With specific reference to the result in part (b), discuss the potential error that Grant may make by using YT and Y1 as the basis of his estimate of the return to migration.