Chapter 6 – Human Capital
Review Questions: 2, 3, 5, 6, 7, 8 and 10 on pages 282 and 283
Schooling model - Basics
2 – Discuss how the wage-schooling locus is determined in the labor market and
why it is upward sloping and concave.
3 – Derive the stopping rule for investments in education.
Empirical problems in estimating returns to schooling (ability bias & Selection bias)
5 – Discuss how differences in discount rates or in ability across workers lead to
differences in earnings and schooling. Under what conditions can the rate of return
to schooling be estimated?
6 – Discuss the relationship between ability bias in the estimation of the rate of
return to schooling and selection bias in tests of the hypothesis that workers choose
the level of schooling that maximizes the present value of earnings.
7 – Discuss how empirical studies estimate the rate of return to schooling and the
methods used to avoid the problem of ability bias.
Signalling
8 – Show how education can signal the worker’s innate ability in the labor market.
What is a pooled equilibrium? What is a perfectly separating signaling equilibrium?
General vs Specific Training
10 – Discuss the difference between general training and specific training. Who pays
for and collects the returns from each type of training?
Problems: 1,2,6,8, 12 on pages 283-285
Schooling decision
6-1. Debbie is about to choose a career path. She has narrowed her options to two
alternatives. She can either become a marine biologist or a concert pianist. Debbie
lives two periods. In the first, she gets an education. In the second, she works in the
labor market. If Debbie becomes a marine biologist, she will spend $15,000 on
education in the first period and earn $472,000 in the second period. If she becomes
a concert pianist, she will spend $40,000 on education in the first period and then
earn $500,000 in the second period.
(a) Suppose Debbie can lend and borrow money at a 5 percent rate of interest
between the two periods. Which career will she pursue? What if she can lend and
borrow money at a 15 percent rate of interest? Will she choose a different option?
Why?
(b) Suppose musical conservatories raise their tuition so that it now costs Debbie
$60,000 to become a concert pianist. What career will Debbie pursue if the interest
rate is 5 percent?
6-2. Peter lives for three periods. He is currently considering three alternative
education-work options. He can start working immediately, earning $100,000 in
period 1, $110,000 in period 2 (as his work experience leads to higher productivity),
and $90,000 in period 3 (as his skills become obsolete and physical abilities
deteriorate). Alternatively, he can spend $50,000 to attend college in period 1 and
then earn $180,000 in periods 2 and 3. Finally, he can receive a doctorate degree in
period 2 after completing his college education in period 1. This last option will cost
him nothing when he is attending graduate school in the second period as his
expenses on tuition and books will be covered by a research assistantship. After
receiving his doctorate, he will become a professor in a business school and earn
$400,000 in period 3. Peter’s discount rate is 20 percent per period. What education
path maximizes Peter’s net present value of his lifetime earnings?
6-6. Suppose Carl’s wage-schooling locus is given by
Years of Schooling
9
10
11
12
13
14
Earnings
$18,500
$20,350
$22,000
$23,100
$23,900
$24,000
Derive the marginal rate of return schedule. When will Carl quit school if his
discount rate is 4 percent? What if the discount rate is 9 percent?
Signalling
6-8. Suppose there are two types of persons: high-ability and low-ability. A
particular diploma costs a high-ability person $8,000 and costs a low-ability person
$20,000. Firms wish to use education as a screening device where they intend to pay
$25,000 to workers without a diploma and $K to those with a diploma. In what
range must K be to make this an effective screening device?
Program Evaluation
6-12. In 1970, men aged 18 to 25 were subject to the military draft to serve in the
Vietnam War. A man could qualify for a student deferment, however, if he was
enrolled in college and made satisfactory progress on obtaining a degree. By 1975,
the draft was no longer in existence. The draft did not pertain to women. Using the
data in Table 269 of the 2008 edition of the U.S. Statistical Abstract, use women as
the control group to estimate (using the difference-in-differences methodology) the
effect abolishing the draft had on male college enrollment.
Men
Women
College Enrollment (%)
1970
1975
55.2
52.6
48.5
49.0