Question 1

Consider a perfectly competitive labor market. Suppose there areH^s high skill workers andL^slow skill workers. Suppose there is free entry of firms, which demand high and low skill labor, taking wageswi, fori=L, H, as given, to solve:

max{Y(L,H)w_LLw_HH},

^L,H

whereY(H, L)is the output that is produced by combiningHandLunits of high-skill and low-skill labor.

Characterize the equilibrium wages paid to low-skill and high-skill workers.

Question 2

Now suppose the production technology is given by

Y(H, L) =AL¹H,

with0< <1. Derive an expression for the skill premium as a function of the relative supply of skills.

Explain (i) what happens to the skill premium asH/Lincreases and (ii) how the effect depends on.