© 2002 McGraw-Hill Ryerson Ltd.Chapter 9-1 Chapter Nine Human Capital Theory: Applications to Education and Training Created by: Erica Morrill, M.Ed Fanshawe.
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© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-1
Chapter Nine
Human Capital Theory: Applications
to Education and Training
Created by: Erica Morrill, M.Ed Fanshawe College
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-2
Chapter FocusFactors that determine the market rate
of return to education Is education economically worthwhile? Is education a predictor of greater
productivity?Market signaling and screeningGovernment-funded training programs
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-3
Human Capital Theory Investments are made to improve
productivity and earningsCosts incurred with the expectation of
future benefitsBenefits must exceed costs by a
significant amount
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-4
CostsDirect costs
books, tuitionOpportunity cost
income forgonePrivate Costs/Social CostsReal Costs/Pecuniary or transfer costs
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-5
Figure 9.1 Alternative Income StreamsEarnings
16 18 22
dDirect costs
a
Stream Abe
Stream B
c
fStream C
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-6
Age-Earnings Profiles Increase with age but at a decreasing
rateHigher for those with more education
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-7
Choosing an Income StreamSimplifying assumptions
no direct utility or disutility from education hours of work are fixed income streams associated with education
amounts are known individuals can borrow and lend at the real
interest rates
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-8
Human Capital Investment Decision
Quantity of education maximizes the net present value of lifetime
earnings
Human capital wealth can be distributed by borrowing and lending
Increase education until… present value of benefits of additional year equals
present value of additional costs
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-9
Implications of Theory Investment should be made early in
one’s lifeLittle incentive for individuals
experiencing discontinuity in workforce
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-10
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
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-11
Optimal Human Capital Investment
Expressed in terms of…. Costs and benefits Marginal costs and benefits Rate of return on investment
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-12
Education and Market Equilibrium
Interaction between individuals’ preferences employers’ preferences
Human capital positively affects productivity of workers
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-13
Figure 9.3 Education and Market Equilibrium
Years of Education
Wage
I
I
UB
EB
UA
EA
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-14
Education as a FilterEducation acts as a signal of the
productivity of employeesHigher wages are offered if employers
believe that education increases productivity
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-15
Figure 9.4 Offered Wage and Signaling
Cost Schedules
WagesW(y)
Education
CL(y)
W(y)
CH(y)
1
2
y*1 2
Cost of education C(y)
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-16
Empirical Evidence Education and Earnings
Earnings increase with age experience Increase is most rapid to age 45 or 55
for individuals with the most educationDifferential is wider between groups at
ages 45-50 than 20-30
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-17
Human Capital Earnings Function
Estimates the rate of return to educationLeast-squares regression of earnings
on educationControls for other factors that may affect
earnings
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-18
Signaling, Screening and AbilityDeterminants difficult to control
innate abilitySignaling/screeningPrivate return on educationSocial return on education
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-19
Addressing Ability BiasNatural experiments
isolate the influence of education from unobserved ability factors
research on twins compulsory school attendance laws proximity to college findings
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-20
Increased Returns to Education and Inequality
Variation of returns to schooling over time
Increased returns have coincided with increases in income inequality
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-21
TrainingGeneral 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
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-22
Figure 9.7 a Costs, Benefits and Financing of Training
Wa=VMPa
Time
WagesVMP
Costs and Benefits of Training
costs
benefits
0
VMP*
VMPt
t*training
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-23
Figure 9.7 b Costs, Benefits and Financing of Training
Wa=VMPa
Time
WagesVMP
Specific training as a shared investment
0 t*training
Employer’s costs
Employee’s benefits
VMP*
VMPt
Employee’s costsWt
Employer’s benefitsW*
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-24
Figure 9.7 c Costs, Benefits and Financing of Training
Wa=VMPa
Time
WagesVMP
Earnings growth with gradual training
0
VMP*
VMP0
Employer’s costs
Employer’s benefits
Employee’s benefits
Employee’s costs
Wt
W*
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-25
Appropriate Role of Government Private markets may not provide socially
optimal amounts of training imperfect information regulatory restrictions contract problems
Training subsidies to disadvantaged could increase working hours raise wages above the poverty line
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-26
Evaluation of Government Training Programs
Difficulties in evaluation no opportunity to observe earnings in the
absence of training no control group many variables
© 2002 McGraw-Hill Ryerson Ltd. Chapter 9-27
End of Chapter Nine
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