Chapter 9-1

Chapter Nine

Human Capital Theory: Applications

to Education and Training

Modified from Slides Created by Erica Morrill

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

Chapter 9-3

Human Capital Theory Investments are made to improve

productivity and earningsCosts incurred with the expectation of

future benefits Investment takes place when benefits

exceed costs by a significant amount

Chapter 9-4

CostsDirect costs

books, tuitionOpportunity cost

forgone incomePrivate Costs vs Social Costs

Chapter 9-5

Figure 9.1 Alternative Income StreamsEarnings

16 18 22

dDirect costs

a

Stream Abe

Stream B

c

fStream C

Chapter 9-6

Age-Earnings Profiles Increase with age but at a decreasing

rateHigher for those with more education

Chapter 9-7

Choosing an Income StreamSimplifying 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 Yhdiscount ratecost 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 educationDifferential is wider between groups at

ages 45-50 than 20-30

Chapter 9-11

Other Factors Influencing Education

Income tax increase in progressivity of taxes reduce

demand for educationStudent 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

WagesW(y)

Education

CL(y)

W(y)

CH(y)

1

2

y*1 2

Cost of education C(y)

Chapter 9-15

Signaling Model: ImplicationsStandard must be set at the right rangeMultiple equilibriaDiscrimination can lead to a different

education choice by men and women

Chapter 9-16

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

Chapter 9-17

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

Chapter 9-18

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*

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