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Lec15-Edu_Human_Capital_Labor_Market_Signaling

Lec15-Edu_Human_Capital_Labor_Market_Signaling - Lecture...

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Lecture Note #15: Education, Human Capital, and Labor Market Signaling David Autor 14.03, Microeconomic Theory and Public Policy, Fall 2005 Our prior discussion of the Full Disclosure Principle suggests that markets can e¢ ciently solve information problems if information disclosure is credible and free. But the Full Disclosure Principle says nothing about whether this process will be e¢ cient when disclosure is credible but costly. The Akerlof model (and the Rothschild-Stiglitz model, which we won°t have time to cover this term) show that there can be too little information disclosure when information disclosure is credible but not free. The signaling model of Spence (1973) demonstrates there can also be too much information disclosure when information disclosure is credible but not free. In general, disclosing information is not in itself harmful. But the social value of the information disclosed may not be worth the cost of conveying it. This is the insight of the Signaling model. The incentives for disclosure or non-disclosure are purely private. These private incentives may or may not generate desirable outcomes, judged by the standard of social e¢ ciency. 1 Context: Educational investment ° Education is perhaps the most signi±cant investment decision you (or your parents) will make. ° Most citizens of developed countries spend 12 ± 20 years of their lives in school. This involves two types of costs: ° Direct costs: Buildings, teachers, textbooks, etc. (The U.S. spends 5 percent of Gross Domestic Product on direct costs of public education alone.) ° Indirect costs: Opportunity costs of attending school instead of working or having fun. These costs probably swamp the direct costs of schooling. 1
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° Is this enormous investment socially e¢ cient? ° Economics has historically used one canonical model to think about educational invest- ment, the Human Capital of Becker (1964). This model says the answer is likely to be yes. ° Spence suggested a second model: the signaling model. ° We° ll compare and contrast these models. 2 A simpli±ed human capital investment model (due to Jacob Mincer °the ²equalizing di/erences³model) ° De±ne w ( s ) as the wage of someone with s years of schooling. ° Assume w 0 ( s ) , productivity and hence earnings rise with schooling. ° Assume that the direct costs of schooling, c , are zero for now. ° De±ne r > 0 as the interest rate. ° For simplicity, assume people are in±nitely lived ( 40 years is almost as good as in±nity in models with time discounting). ° What is the bene±t from a year of schooling? It is w (1) in perpetuity²the Discounted Present Value (DPV) of w (1) , DPV w (1) = w (1) + w (1) 1 + r + w (1) (1 + r ) 2 + :::: + w (1) (1 + r ) 1 ; which can be solved as follows: DPV [ w (1)] ² ° 1 1 + r ± = w (1) 1 + r + w (1) (1 + r ) 2 + w (1) (1 + r ) 3 + :::: + w (1) (1 + r ) 1 ; DPV ² w (1) ² ° 1 ± 1 1 + r ±³ = w (1) ; DPV w (1) = w (1) ° 1 + r r ± : ° Note that you do not receive the ±rst payment of w (1) right away³ must wait one year while in school. So the bene±t of one year of education is w (1) ´ 1+ r r µ ´ 1 1+ r µ = w (1) r : 2
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° What is the opportunity cost of obtaining one year of schooling? This must be equal to
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