Demand for Education

HS 156
Microeconomic foundations education
  Education as creation of minimum capabilities – Nobel
Laureate Amartya Sen puts forward the idea of functioning –
the ability to read, calculate and process information so as to

Why people go live a normal life with dignity.

to schools?  Education as investment in human capital – Nobel Laureate

Gary Becker portrays education as investment in human
capital.
  Ownership of an economic resource may not always generate utility because the
person might be unable to extract benefits from its use.

 This brings in the necessity of functioning that helps individuals carry out
ordinary business of life.

 Simple capabilities such as of reading and computing can help us perform such
tasks of a normal social life like finding a street address, enrolling a child at school,
Education as reading instructions etc. Thus some level of education creates additional utility.

creation of A list of ordinary life acts that

require some education in order to be
capabilities performed successfully:

• Using public transport

• Finding a street address
• Checking a bill
• Signing a cheque
• Enrolling your child in school
• Reading the instructions on
electrical appliances etc.
  Basic capabilities can be acquired even with minimum
education. But often individuals choose to attain education
beyond the minimum requirement. This is because education,
like that of health, also act as an investment good.
Education as  Educational choice are smart investment decisions where

investment in current income opportunities are renounced in exchange for

better income prospects in the future.
human capital  Buying a capital good today help us earn rents but also there is
a net depreciation associated with its usage. Physical capital is
demanded up to the point where marginal productivity =user
cost.
  One approach is to look at education as a commodity.

 People go to school because they enjoy acquiring new

knowledge.
Why do some individuals
choose to continue  Standard theory of utility maximization predicts that the
education beyond
optimal demand for education will be when marginal utility of
minimum requirement?
additional knowledge is equal to the marginal disutility of
giving up alternative uses of the time involved.

 But can the same be said for tertiary (higher) education?

  In case of tertiary schooling, cost increases significantly when compared to
secondary education, without any evidence of increased pleasure in attending
university lectures.

 Thus, tertiary education cannot be conceived of merely as a commodity.

Tertiary education
cannot be perceived  We could look at tertiary education choice as an investment decision, where current
as merely a income opportunities are renounced in exchange for better future income prospects.

commodity
 This is equivalent to purchasing a production unit today in order to obtain the rents
associated with its ownership, net of depreciation.

 But is the analogy between investment in physical capital and investment in

human capital precise?
  Human capital is incorporated in human beings, and cannot be resold.
What are the differences between physical capital and human capital?
Physical capital can be acquired at (almost) any desired amount in boom periods and be resold during
recession on secondary markets.

 Human capital can be acquired mostly at the beginning of individual life. The pace of accumulation
is determined by physiological factors, and it cannot be resold.

The feature of human capital being embodied in human beings and being irreversible lead to many market
failures.
Difference between  When takin a loan from a bank for physical investment, we can collateralize physical assets; but while
human capital and taking education loan, we cannot collateralize the incorporated knowledge.

physical capital  There is a possibility of moral hazard in case of human capital but not in case of physical capital.

The future benefits of acquiring education now are conditional on exerting adequate effort in the labour
market. But it is impossible to predict if the individual concerned will put that effort in the labour market in
future or not.

In that sense, the current investment in education is riskier than any other financial investment (at least from
the point of view of investing agents – i.e. the parents).

 Finally, an owner of physical capital has a degree of control over it. They may be a bonafide “capitalist”
or “rentier” i.e. drawing an income from the capital or rent from the property in future.

An educated person who owns his/her human capital cannot employ it in a production process unless hired as
a dependent worker, in which case, he/she becomes a wage earner. Thus, human capital does not command
the same market power as does physical capital.
  The standard model of human capital investment argues that
each individual will acquire education up to a point where the
cost of acquisition (direct and indirect monetary costs) equals
the benefit of acquisition ( the discounted value of the earnings

Model of increase due to human capital accumulation).

 Thus two obvious conclusions are that:
human capital a) More talented people will demand more education because
investment their marginal return is higher. Unobservable ability is an
important factor of demand for education.
b) The demand for education is higher when future expected
gain is higher relative to current earnings.
  The visualisation is more clear through Fig 1.
 The cost schedule is upward sloping depicting increasing costs
(both monetary and non-monetary) for higher levels of
education.
 The return schedule is downward sloping to account for the
Model of decreasing return on production technology of new human
capital.
human capital  Time devoted to education here means the years of schooling.
investment  Fig 1 also help us understand why different individuals demand
different amounts of education. With unobservable ability (or
‘talent’) individuals may experience a higher marginal return
for any portion of time invested in education.
  Suppose an individual is optimally choosing the amount of education E1.
corresponding to the intersection of marginal cost with marginal benefit
at point A.
 When she expects that in the next period there will be an increase in the
demand for skilled labour, the (perceived) relative return to education
will rise. This is represented as an outward shift of the marginal return,
leading to an increase in the demand for education up to value E2.
Model of human
capital
investment

Fig 1: Model of human capital investment

Source: Checchi (2005)