Introduction to the economics of education

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Introduction to the economics of
education
Craig Holmes
Higher Education and the Economy seminar
13th October 2014
www.skope.ox.ac.uk
Course introduction
•
•
•
•
What will we study in this course?
Who will teach you?
Who are you?
Before we start, what do think about higher
education and its relationship to the economy?
www.skope.ox.ac.uk
Seminar outline
• Aims:
– Understand how economists think about individual
decisions, and apply that to the decision to participate in
higher education
– Understand how economists think about social outcomes,
to provide a framework for analysing the effectiveness and
efficiency of higher education policy
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Why do (higher) education?
• Economists’ focus on two areas:
– For its own sake – a consumption good
– For its delayed earnings benefits – an investment
good
• Both connected by a theory: utility
maximisation
– All economic choices produce benefits and costs
– It is rational to choose something providing the
benefits outweigh the costs
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Education as a consumption good
• Benefits (increase utility):
– Enjoyment of learning
– Social life
• Costs (decrease utility):
– Price of course
– Effort of studying
– Opportunity costs – what else could you be doing
with your time or spending your money on?
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Consumption
Value
Marginal costs
Marginal benefits
Amount of consumption
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Consumption
Value
Benefits
Costs
Undergraduate
Master’s
PhD
Education
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Education as an investment
• Some of the benefits to education arise after the
course has been completed
–
–
–
–
–
Higher wages
Greater chance of employment
Better jobs (non-monetary in work rewards)
Further opportunities to learn or train
Any others?
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Education as an investment
• How do you value a delayed benefit?
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Education as an investment
• Like consumption:
–
–
–
–
More investment usually leads to more (delayed) benefits
There are diminishing returns to investment
These benefits must be weighed against the costs
There is an optimal level of investment
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Investment
Value
MC (high course
costs)
MC (low course
costs)
Marginal benefits
(immediate +
delayed)
Amount of education
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Demand for education
Price
Individual
demand
Amount of education
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A market for education
• Total demand for education is the sum of all individual
demands at each price level
• Education providers offer a certain amount of places at each
price.
– In a competitive market, education providers will keep offering places
until the cost of adding an extra place exceeds the price paid for that
place
– Like students – marginal benefit equals marginal cost
• A market is where buyers (demand) and sellers (supply) come
together. A market price ensures that supply and demand are
equal.
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A market for education
Price
Supply of places
Total demand
Amount of education
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Education as an investment
• Why do the delayed benefits arise?
• Two theories:
– Human capital theory
– Signalling and screening
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Human capital theory
• What do you understand by the term ‘human
capital’
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Human capital theory
• “Laborers have become capitalists not from a diffusion of
the
ownership of corporation stocks, as folklore would have it, but
from the acquisition of knowledge and skill that have
economic value” (Schultz, 1961, pg. 3)
• Human capital represents the qualitative differences in
productivity of workers.
• Like other sorts of capital it:
– Requires a costly investment up-front
– Produces a return
– May depreciate
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Human capital theory
•
•
Investment  Increased productivity  Higher rewards
For the worker who receives some education or training
– Additional skills make workers more productive
– Workers are employed by firms – their extra output is sold
by the firm
– Firms profits rise
– Why do workers see higher pay?
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Human capital
•
•
Link between productivity and wages through competition in
the labour market
Example:
– There are many firms producing gubbins in a market,
which sell for £1 each
– An uneducated worker produces 100 gubbins each week.
How much does a firm pay that worker?
– An educated worker produces 200 gubbins each week –
what would happen if a firm offered her the same wage
as her untrained colleagues?
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Human capital
•
How does higher education add to a person’s human capital?
What sorts of human capital is it best a producing?
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Human capital
•
•
•
•
Human capital is not all the same
Moreover, the value placed on it can vary from employer to
employer
Becker distinguished between two sorts of human capital:
– General human capital: improves productivity of workers
regardless of job
– Specific human capital: improves productivity of workers
in a particular job
Examples?
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Human capital
•
Who pays for a general HC investment? Back to our gubbin
market:
– A worker can produce 100 more gubbins a week if they do
a course in the science of gubbins.
– We saw before that trained workers earned £100 more
per week than untrained workers
– Firm net profit = £0. Therefore, they will not pay for
course.
– Worker benefit from investment = £100 per week. Should
they pay for themselves?
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Human capital
•
Who pays for a specific HC investment?
– A firm patents the Gubbin-o-matic, a new machine for
making gubbins
– A worker can produce 100 more gubbins a week if they go
to the Gubbin-o-matic Training Seminar
– Firms would not pay trained workers any more than
before. Why?
– Worker benefit from investment = £0 per week. They will
not pay for training
– Firm net profit = £100 per week. Will they pay for workers
to take the course?
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Human capital
•
•
Individuals pay for general human capital, while firms pay for
specific human capital?
Does higher education produce general or specific human
capital?
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Human capital and the market for
education
•
•
Why does the state sometimes pay for higher education?
Everything we have talked about so far happens through
hypothetical competitive markets for education, training and
skills
– Extra wages = extra productivity  private benefits = social benefits
– Price is set as low as possible  private costs = social costs
– Price is set to equate supply and demand  marginal benefit =
marginal cost. As a result, marginal social benefits = marginal social
costs.
– This outcome is efficient – all socially worthwhile investments take
place
www.skope.ox.ac.uk
Market failures
•
The model has assumed that markets work well:
– Everyone is well informed about all opportunities to invest.
– Labour markets are competitive – many firms and many workers,
none of whom have any market power
– Markets for training provision are competitive
– Finance is readily available to fund investments
– The decision to invest affects only those involved (e.g. the individual
or the employing firm)
•
•
A breakdown in any of these conditions leads to market
failure  an inefficient amount of investment
Could any of these apply to a market for higher education?
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Correcting market failure
Value
Marginal costs
Social marginal
benefits
Private marginal
benefits
Amount of investment
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Correcting market failure
Value
Marginal costs
Subsidy
Social marginal
benefits
Private marginal
benefits
Amount of investment
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Correcting market failure
• How else could the state intervene, other than
through direct subsidy?
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Signalling
• Spence (1973):
– Suppose that individuals differ in productive capabilities, regardless of
education
– Simple case: low ability (100 gubbins per week) and high ability (200
gubbins per week) in a competitive market.
– Individuals know their ability.
– Employers can not directly observe this ability.
• High ability workers want to ‘signal’ their ability.
• Education can act as a signal if more costly to low ability
workers to acquire
• Employers have beliefs about education-ability link
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Signalling
Wage,
output
Cost (low)
200
Wage
150
Cost (high)
100
Education
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Signalling
Wage,
output
Cost (low)
200
Wage
Cost (high)
100
E*
Education
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Signalling
• What is the socially optimal level of education in this
model?
• Zero!
• Total output is the same regardless of educational
choice. Social benefits = 0
• Education uses resources: social costs > 0
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Job competition
• A related, but separate theory, posits that productivity (and
wages) are determined by jobs themselves, not workers
• Workers compete for the best job they can get – education is
one way they position themselves (as it signals certain
characteristics that employers like ability to learn the job)
• This does not exclude elements of human capital theory – for
example, some jobs require skills to be present at the point of
entry.
• Unlike HCT, this is a zero-sum game – if an individual move up
the job queue, it pushes someone else down.
www.skope.ox.ac.uk
Job competition
• Unlike HCT and signalling, job competition allows for
overeducation - a particular concern for university
leavers
• Job competition emphasises that the demand side of
the labour market (employers) is as important as the
supply side of the labour market (workers) – policy
tends to focus on the latter.
www.skope.ox.ac.uk
Exercise
• Many countries have seen an increase in higher education
participation in recent years:
•
Consider explanations and consequences of this trend from
the perspective of (a) human capital theory (b) signalling,
and (c) job competition
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How does this relate to the rest of
the course?
• Next week: measuring the returns to investing in
higher education – quantifying the private benefits
• Transitions into the labour market – keep in mind
human capital, signalling and job competition
• Who pays? Remember private vs. social benefits
• HE and economic growth – productivity and
externalities
• Too big? All about finding the social optimum
www.skope.ox.ac.uk
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