Job Market Signaling-Michael Spence

Objectives of this paper

01
Definition and the idea of
Job Market Signaling
05 Informational feedback and the
definition of equilibrium
02 Introduction

06
Properties of informational
Hiring as investment equilibria: with an example.
03 under uncertainty

The informational
Applicant 07
04 impact of indices
signaling

08 Conclusion
What is Signaling

Fig 1: A Sequencial Game

Job Market Signaling
Hiring as Investment Under Uncertainty
Applicant signaling

Fig 3: Employees applying for different Jobs

 Applicant signaling
A Critical Assumption

Fig 4: Informational Feedback in the Job Market

 Benchmark Model

Type of Worker Marginal product Proportion of population

Low productivity 1 q

High productivity 2 1-q

✓ No signaling

• High & low productivity workers are not distinguishable

• All gets a wage equal to the expected marginal product,

Wage = 1*q + 2*(1-q) = 2-q

✓ Members of Group 1 are better off by a magnitude of 1 − q.

✓ Members of Group 2 are hurt by a magnitude of −q, which increases as q increases.
Signaling Model of Education - Separating Equilibria

Type of Worker Marginal Proportion of Cost of education

product population level y
Low productivity 1 q y
(Group 1)
High 2 1-q y/2
productivity
(Group 2)
Group 1 with 0 year of schooling
Group 2 with some years of schooling
Signaling costs, negatively correlated
with productivity

✓ Payment scales according to

employer’s beliefs
-If a worker has at least y* years
of scooling, he/she earns $2 Fig 5: Offered wages as a function of level of education
-If a worker has less than y* years
of scooling, he/she earns $1
Low productive workers without a degree are not likely to get a degree
(y=0) if-


Earnings without a degree > earnings with a degree – cost of getting the
degree

1 > 2-y*

y* > 1

High productive workers are likely to get a degree (y=y*) if-


Earnings without a degree < earnings with a degree – cost of getting

1 < 2-(y*/2)

y* < 2

Basically , 1 < y* < 2 is the condition

that needs to be satisfied to confirm the
employer’s beliefs earned by market
experience as well as to get separating
equilibrium

Fig 6:Optimizing choice of education for both groups

What if y* increases in this case

Group 1 will be unaffected as net payoff = 1

Group 2 will be negatively affected as net payoff = 2-(y*/2)

Comparing This Signaling Model With Benchmark Model

Assumption : q = 0.5 & y* = 1.6

oAccording to benchmark model, both groups’ net payoff = 2-q = 1.5.

oAccording to the signaling model of education, Group 1s’ net payoff = 1 < 1.5
Group 2s’ net payoff = 2-(1.6/2) = 1.2 < 1.5
Then both would prefer no signaling situation

Exceptional Cases

Group 2 will prefer signaling only if, 2-(y*/2) > 2-q Or, y* < 2q
• Thus, q needs to be greater than 0.5 as 1 < y* < 2
which basically indicates that Group 2 needs to be a minority group to prefer signaling.
 Generalized Signaling Model
✓Value of q depending upon the ratio of marginal signaling cost of the two groups

Assumption : a > b

Type of Marginal Proportion of Cost of

Given the employer’s initial beliefs, in equilibrium- Worker product population education level
y
Group 1 sets y = 0 if
Low 1 q ay
 1 > 2 − ay* productivity
(Group 1)
 y* > 1/a
High 2 1-q by
Group 2 sets y = y* if productivity
 2 − by* > 1 (Group 2)

 y* < 1/b
Then the condition on y* is given by 1/a < y* < 1/b
As long as y* is within these bounds, a signaling equilibrium
holds.
We can modify the inequality for better explanation
1/a < y* < 1/b
 b/a < by* < 1

However, to make Group 2 better off for this signaling equilibrium y*,
we need
Net payoff with signaling > net payoff with no signaling
 2 − by* > 2 − q
 2 – b/a > 2 – by* > 2-q
 2 – b/a > 2 – q
 q > b/a

If this condition is satisfied, group 2 will be better off with signaling.

A Real Life Example of Separating Equilibria
 Pooling Equilibria

• All type of workers send same signal

• End up with a wage equal to the expected marginal product, 2-q

CASE 1

✓ Employer’s Initial beliefs -

• The low and high productivity who do not signal assumed not to be
distinguishable, the wage for y = 0 is the no signaling wage 2 − q
• A worker who signals is high productivity, the wage for y = y* is the high
The high productivity wage 2

✓ Given these initial beliefs, in equilibrium,

Group 2 sets y = 0 if 2 − q – 0 > 2 − y*/2 Or, y* > 2q Fig 7: Optimal Signaling Decisions For 2
Groups
• Group 2 will not signal resulting in a pooling equilibrium
• No onei signals and earns 2-q
• No data to disconfirm employer beliefs thus the equilibrium holds
  CASE 2
✓ The employer’s beliefs are as follows
• The low and the high productivity workers who do invest in a signal are not
distinguishable, wage for y=y* is now 2-q
• A worker is low productivity if a worker do not signal, wage for y=0 is 1

✓ Given this form of initial beliefs, in equilibrium,

Group 1 sets y = y* if 1 < 2 − q − y* Or, y* < 1 - q

• Group 1 signals, resulting again in a pooling equilibrium

• Everyone signals & earns 2 − q

Do Signaling Equilibria Exist In General?

 How general are the properties of the
examples considered here?

❌ Generality
✔️Illustration of some essential properties of signaling equilibria.

 Separating Equilibria
• Employer’s set of beliefs gained by market experience are confirmed or at least not
contradicted by the new data
• Perfect point predictions by employers concerning the productivity of any individual,
having observed his/her level of education
• Inequivalent from the point of view of welfare
• Education as an entrance requirement or prerequisite for the high-salary job
• Private & social returns differ
• Pareto inferior equilibria

 Pooling Equilibria
• The education level conveys no useful information
but still people do invest in education
• Absence of any correlation between educational
costs and productivity

✓ Effective Signaling
• The negative correlation of costs and productivity
• A sufficient number of signals within the appropriate cost range
 Indices

Race Sex Nationality

We will look into indices now after signaling

Here, for concreteness, we will choose indices ‘SEX’
It will be observable and unalterable
 Assumption

Men (M) Women (W)

Within them the distribution of signaling productivities and signaling
costs are the same.
 Data of the Model

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 Informational Impact of SEX
Sex could never tell the
employer about productivity

Sex and productivity

are uncorrelated in
the population If sex has to have any informational
impact, it must be with education
symmetry

Therefore, no
informational impact Men and women bearing
same signaling cost decides
alike
Denying last
If men and women are not bearing
Conclusion same education costs, then the
returns will also differ
The opportunity sets of men
and women differs in the
comparative productivity
This situation can
Similarity in probabilistic beliefs like as arise equilibrium
education, if employers distribution
conditional on sex and education

Externality decision of both men

and women holds
 Sex Two
Potential
Signals
Education

They both are correlated with productivity

now
Some Forms of Equilibrium

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If W and y < y*w, productivity = 1 with probability 1

If W and y>y*w, productivity =2 with probability 1.

If M and y <y*M, productivity =1 with probability 1

If M and y>y*M, productivity= 2 with probability 1.

 Graphical explanation

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Fig 8: Offered waged to W and M

Here, Ww(y) and Wm(y) are the offered wages and Y is the employers expectation levels.
Required equilibrium conditions are y*w and y*m which denotes 1<y*w<2 and 1<y*m<2
and signaling equilibria are equivalent
 View of Social Welfare

01 Signaling equilibria are not equivalent

02 The higher the y*w or y*m, the worse is the

relevant group (Pareto inferior)

03 In case of higher productivity, the women

have to spend more on education or signaling
cost should be more, otherwise employer
wouldn’t accept them.
04 High and low productivity of each group
doesn’t affect the market equilibrium

Fig 9: Market equilibrium with sex as an index

 Graphical Explanation
Here men and women are independent
and, many equilibrium takes place
For example, we might have men signaling at
y=y*m=1.1 if they are high productive. While
other men set y=0. Similarly, all women may
choose y=0
If W sets y=0, Women are paid 2-q1 and y*m
should be greater than 2q1. So wage of all
women including lower productivity would be
higher than lower productive men. Gives rise to
wage discrimination.
The returns from signaling of women
with productivity 2 is higher.
2-q1> w-y*M/2
It will occur when, 2q1<Y*M

Fig 10: Another equilibrium configuration in the It might seem that due to the less education
market women might get less wages. Writer here
assumed it. It might be wrong
 Some Questions

“What is the effect of signaling cost that differ

systematically with indices”

“What kinds of discriminatory mechanisms are implicit in,

or interact with, the informational structure of the market,
Column
and what policies are effective or ineffective in dealing
with them?”
Infographic
 Probable Solutions

Discriminatory mechanisms like variations in

one’s sex or race and due to which wage
discriminations is seen.

Fine may be imposed upon the

employer for differentiation in wages

Interview should be made prior to other

formalities like application and all.
Main message of this paper

Structure of the simplest

model of Job Market
signaling by which an
employer can detect an
appropriate employee and
the problem of ‘adverse
selection’ can be avoided.
 Some
Limitations
This model speaks about education as a
signaling, but in many cases, education is
alterable and it create disturbances.

Also, this paper assumes certain conditions

like, men’s signaling costs is higher than
women in case of lower productivity and vice
Like every work, versa which might not be always true
this paper is also
not devoid of It also gives rise to some sort of discrimination
some limitations in the society through different wages.
Any Question?