Signaling & Screening (Spence)
Costly signals that separate types, why education can pay even if it teaches nothing.
Definition
Responses to hidden types: informed parties SIGNAL (costly actions that only good types find worthwhile, e.g. Spence's education), uninformed parties SCREEN (menus that make types self-select).
Key equation
Separating equilibrium: signal cost(good type) < wage gain < signal cost(bad type)
The intuition
A degree can raise your wage even if it teaches nothing, provided it's sufficiently harder for low-ability people to obtain, employers read the diploma as evidence. Insurers do it in reverse: high-deductible-cheap and low-deductible-dear contracts sort the healthy from the sick.
Exam tip
The single-crossing condition (signal costs differ by type) is what makes separation possible, state it.
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