Chapter 9: The Economics of Education

Overview

• robust relationship between education and earnings.

• Why?• What determines the level of education selected

by an individual?

Human capital model

• human capital - an individual’s productive capacity.

• human capital may be increased by investments in:– education,

– training, and

– health care.

• individuals with more human capital receive higher pay (since they are more productive).

Optimal investment in education

• invest in additional education only if PV(benefits) is at least as large as PV (costs).

Costs of college education

• direct costs (tuition, books, supplies),• forgone earnings (opportunity cost of time), and• psychic costs.

Benefits of college education

• higher expected earnings,• more pleasant jobs,• lower expected unemployment rates, and• psychic benefits.

Optimal investment in education

Choice between high school and college degree

Factors influencing human capital investment

• interest rates,• the age of the individual,• the costs of education, and• the wage differential between high school and

college graduates.

Age-earnings profile

• Age-earnings profiles are concave (the rate of increase in earnings decreases as individuals age).

• This is caused by:– a decline in human capital investment as individuals

age, and

– sometimes partly due to declines in physical strength as individuals become older.

Gender and age-earnings profiles

• historically, women have had shorter expected worklives.

• lower incentives for investment in education.• increases in female educational attainment are

caused by (and are a cause of) increased expected worklives for women.

Is a college education a good investment?

• estimated rate of return: 5-12%• some evidence of an increase in recent years.

Possible biases in estimates of the rate of return to education

• ability bias (an upward bias),• nonpecuniary benefits (downward bias), and• selectivity bias.

Is there a socially optimal level of investment in college education?

• externalities and subsidies.• signaling model.

Cobweb model

• lagged supply response.• applicable in labor markets with high educational

and/or training requirements.

Cobweb model (cont.)

Cobweb model (cont.)

Cobweb model (cont.)

Cobweb model (cont.)

Cobweb model (cont.)

Cobweb model (cont.)

Cobweb model (cont.)