Chapter 9-1 Chapter Nine Human Capital Theory: Applications to Education and Training Modified from Slides Created by Erica Morrill

Chapter 9-2 Chapter Focus  Factors that determine the market rate of return to education  Is education economically worthwhile?  Is education a predictor of greater productivity?  Market signaling and screening  Government-funded training programs

Chapter 9-3 Human Capital Theory  Investments are made to improve productivity and earnings  Costs incurred with the expectation of future benefits  Investment takes place when benefits exceed costs by a significant amount

Chapter 9-4 Costs  Direct costs  books, tuition  Opportunity cost  forgone income  Private Costs vs Social Costs

Chapter 9-5 Figure 9.1 Alternative Income Streams Earnings d Direct costs a Stream A b e Stream B c f Stream C

Chapter 9-6 Age-Earnings Profiles  Increase with age but at a decreasing rate  Higher for those with more education

Chapter 9-7 Choosing an Income Stream  Simplifying assumptions  no direct utility or disutility from education  income streams associated with education amounts are known  individuals can borrow and lend at the real interest rates

Chapter 9-8 Human Capital Investment Decision  Choose years of education such that the net present value of lifetime earnings is maximized  As comparison, one may compare the present values: high school vs university  V=  (Yc- Yh)/(1+d)^t, where Yc=income stream with college degree; Yh=income stream with high school diploma; d=discount rate; t=time.

Chapter 9-9 Implications of Theory  Investment should be made early in one’s life (age)  Wage difference between Yc and Yh  discount rate  cost of education

Chapter 9-10 Empirical Evidence Education and Earnings  Earnings increase with age experience  Increase is most rapid to age 45 or 55 for individuals with the most education  Differential is wider between groups at ages than 20-30

Chapter 9-11 Other Factors Influencing Education  Income tax  increase in progressivity of taxes reduce demand for education  Student loans  alter marginal cost of education and levels of educational attainment

Chapter 9-12 Education and Market Equilibrium  Interaction between  individuals’ preferences  employers’ preferences  Human capital positively affects productivity of workers

Chapter 9-13 Education as a Filter (by Michael Spence)  Education acts as a signal of the productivity of employees  Higher wages are offered if employers believe that education increases productivity

Chapter 9-14 Figure 9.4 Offered Wage and Signaling Cost Schedules Wages W(y) Education C L (y) W(y) C H (y) 1 2 y* 1 2 Cost of education C(y)

Chapter 9-15 Signaling Model: Implications  Standard must be set at the right range  Multiple equilibria  Discrimination can lead to a different education choice by men and women

Chapter 9-16 Training General Training  Skills used in various firms  Firms will offer higher wage for this training  Trainee willing to bear the cost since higher wages offered for these skills Specific Training  Training useful to the firm that provides the training  Trainee is unwilling to bear the cost because no higher earnings  Firm does not have to pay higher wages because other firms are not competing for such trainees

Chapter 9-17 Figure 9.7 a Costs, Benefits and Financing of Training W a =VMP a Time Wages VMP Costs and Benefits of Training costs benefits 0 VMP* VMP t t* training

Chapter 9-18 Figure 9.7 b Costs, Benefits and Financing of Training W a =VMP a Time Wages VMP Specific training as a shared investment 0 t* training Employer’s costs Employee’s benefits VMP* VMP t Employee’s costs WtWt Employer’s benefits W*

Chapter 9-19 Appropriate Role of Government  Private markets may not provide socially optimal amounts of training  Training subsidies to disadvantaged could  increase working hours  raise wages above the poverty line

Chapter 9-20 End of Chapter Nine