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.)