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Unformatted text preview: Lecture Note 1 8 Education, Human Capital, and Labor Market Signaling 14.03/14.003, Microeconomic Theory and Public Policy, Fall 2009 David Autor, Massachusetts Institute of Technology December 5, 2010 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 show that there can be too little information disclosure. The signaling model of Spence (1973) demonstrates there can also be too much information disclosure. 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 signicant 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 surely swamp the direct costs of schooling. 1 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 simplifed human capital investment model (due to Jacob Mincer the equalizing diFerencesmodel) DeFne w ( s ) as the wage of someone with s years of schooling. Assume w ( s ) , productivity and hence earnings rise with schooling. Assume that the direct costs of schooling, c , are zero for now. DeFne r > as the interest rate. or simplicity, assume people are inFnitely lived ( 40 years is almost as good as inFnity in models with time discounting). What is the beneFt from a year of schooling? It is w (1) in perpetuitythe Discounted Present Value (DPV) of w (1) , w (1) w (1) w (1) DPV w (1) = w (1) + + + .... + , 1 + r (1 + r ) 2 (1 + r ) which can be solved as follows: 1 w (1) w (1) w (1) w (1) DPV [ w (1)] = + + + .... + , 1 + r 1 + r (1 + r ) 2 (1 + r ) 3 (1 + r ) 1 DPV w (1) 1 = w (1) , 1 + r 1 + r DPV w (1) = w (1) ....
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