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The classic wage, schooling, and ability trap

The true model is wage=β1school+β2ability+ε\text{wage} = \beta_1\,\text{school} + \beta_2\,\text{ability} + \varepsilon (centered, ε\varepsilon exogenous). Ability is unobserved, so you regress wage on years of schooling alone.

Derive what your estimated return to schooling converges to, and sign the bias.

Show a hint

Ability plausibly raises wages on its own, and more able people tend to get more schooling. Feed both facts into the OVB formula.

Your answer

This one is open-ended. Work it through, then check your reasoning against the full solution.

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