37 Pages Posted: 8 Feb 2003
Date Written: October 6, 2002
When employers cannot tell whether a school truly has many good students or whether it is just giving easy grades, schools have an incentive to inflate grades to help their mediocre students. However schools also care about preserving the value of good grades for their good students. We construct a signaling model in which grade inflation is the equilibrium outcome. The inability to commit to an honest grading policy in an environment of private information reduces the informativeness of grades and hurts the school. We also show that grade inflation by one school makes it easier for another school to fool the market with grade inflation. Hence easy grades are strategic complements, and this provides a channel to make grade inflation contagious.
Keywords: signaling model, pooling equilibrium, strategic complementarity
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