When applied to the labour market, the adverse selection model suggests that:
A) relatively talented workers are more likely to remain with a paiticular tirm if the firm cut: the wages it pays
B) firms have perfect knowledge about the ability of workers
C) a firm may choose to pay an above-equilibrium wage to attract a better mix of workers
D) all workers have identical abilities.

Question

Quizplus · Accepted Answer

The adverse selection model suggests that there is asymmetric information in the labour market, meaning that firms do not have perfect knowledge about the abilities of all workers. As a result, there is a risk of attracting a pool of low-quality workers if the firm pays only an equilibrium wage. To mitigate this risk, a firm may choose to pay an above-equilibrium wage to attract a better mix of workers. This is known as a signaling mechanism, where a higher wage signals to potential employees that the firm values highly skilled workers and is willing to pay a premium for them. Therefore, option C is the best choice. Option A is incorrect because if a firm cuts wages, it is more likely to retain lower-quality workers who are willing to work for lower pay. Option B is incorrect because the adverse selection model assumes that firms do not have perfect knowledge about workers' abilities. Option D is incorrect because the model assumes that workers have different abilities, which is the source of the asymmetric information problem.

When Applied to the Labour Market, the Adverse Selection Model