Question

Answer according to the human capital model. Assume there are not any non-pecuniary benefits or costs. Also, assume the interest rate is 0.

2. Imagine you are in high school and have to decide whether or not to go to college. If you don’t go to college you can make $30,000 annually until you retire (that is, for 40 years). You must pay $10,000 annually to study 4 years of college. Imagine after graduating you could make $40,000 annually.

a. Should you go to college? Explain with calculations.

b. Now imagine you know that you will stop working for 4 years at some point because you will have kids. Imagine your salary will remain the same after your break. Should you still go to college?

c. Imagine now you have to decide whether to go to college to study economics or computer science. Your salary as an economist will be $40,000 and it will remain the same after your 4 years off from having kids. Your salary as a computer scientist will be $50,000 but it will go down 25% if you stop for 4 years. How many years at a minimum would you have to wait to have kids so that your lifetime earnings as a computer science equal that of an economist? (Use decimals in your answer).

d. Now imagine you can hire a nanny so that you don’t need to stop working after you have kids. If you are a computer scientist, how much at most will you be willing to pay her per year if you want to have kids 10 years after you graduated from college? Does this mean that you should be a nanny instead of a computer scientist?

Answer 1

Answer (a):

If I dont go to College, I will make $30,000 annually for 40 years, i.e total earnings = 40 * 30000 = $1,200,000 (Call it A)

If I go to College, I spend $10,000 for 4 years, i.e Total Spending = 4 * 10000 = $ 40,000

After College I will earn $40,000 annually for 36 years only as 4 years out of 40 years are spent in college.

Hence Total Earnings = 36 * 40000 = $1,440,000

Net Earning = Earning- Spending = 1440000 - 40000 = $ 1,400,000 (Call it B)

Since, Net Earning in case I go to College is more, I should go to college.

Answer (b)

Loss of Earnings for not working 4 years in case I donot attend college = 4 * 30000 = $120,000

Hence, Net Earnings = A - 120000 = 1200000 - 120000 = $ 1,080,000

Loss of Earnings for not working 4 years in case I attend college = 4 * 40000 = $160,000

Hence, Net Earnings = B - 160000 = 1400000 - 160000 = $ 1,240,000

Since, Earnings by attending College is still more, I should still attend College.

Answer (c)

Since as an Economist I am earning $40,000 annually my Net Earning is already calculated in Answer (b) as $1,240,000

Calculating Earnings in case of Computer Scientist:

Spending is same as Economist i.e. $40,000

Earnings will be $50,000 annually till break and will reduce by 25% i.e (25 * 50,000/100) = $12,500. Hence Earning after break = 50000-12500 = $37,500

Lets assume I take break after x years of completing college, so for x years I will earn $50,000 i.e. x * 50,000 = $ 50,000x

After break of 4 years, I will have 36-4-x i.e (32-x) years for which I will earn $37,500 i.e. (32-x) * 37500 = (1200000 - 37500x)

Hence Total Earnings = 50000x + 1200000 - 37500x = 12500x + 1200000

Hence Net Earnings = 12500x +1200000 - 40000 = 12500x + 1160000

This Earning should be equal to Earning from Economist course

Hence 12500x + 1160000 = 1240000

Hence 12500x = 1240000 - 1160000

Hence x = 80000/12500

Hence x = 6.4 years

Hence break shall be taken after 6.4 years (after attending the college)

Answer (d)

To hire a Nanny I can maximum pay my additional earnings because of not stopping to work.

Lets calculate additional earning in case I hire Nanny,

If I hire a Nanny, I will not stop working so I will earn for 4 years more at $50,000 annually i.e. 4 * 50,000 = $200,000

Additionally my earnings will not be reduced by 25% i.e $12,500 (already calculated in answer (c). This I will earn only for remaining years i.e 36-10-4 = 22 years. Hence additional earning will be 22 * 12500 = $275,000

Total Additional Earnings = 200000+ 275000 = $ 475,000

So to hire a Nanny maximum of $ 475,000 can be paid over a period of 4 years i.e 475000/4= $118,750

As a computer scientist my earnings will be $50,000 annually for 36 years i.e 36 * 50000 = $1,800,000 and spending will be $ 40,000. Hence Net Earnings will be 1800000-40000= $1,760,000

Hence my opportunity cost of being a Nanny is = 1760000 - 118750 = $ 1,641,250

Hence it does not mean that I should be a Nanny instead of a Computer Scientist.