Investment in Human Capital ModelPart II

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Topic 3 Part IV
Investment in Human Capital Model-Part II
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Comments on the Human Capital Model Assumptions

• The simplifying assumptions used in the model may
  not hold in practice

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Additional Costs and Benefits from Education

• The model assumes that benefits from education
  are only related to the higher earnings related
  to the higher educational attainment
• Costs are assumed to be related only to the
  expenditures on education and the forgone wage
  during studies

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Additional Costs and Benefits from Education

• However, the process of acquiring education may
  directly yield utility or disutility
• The existence of the consumption component on
  the educational process does not imply that the
  investment component is irrelevant

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Additional Costs and Benefits from Education

• Individual who enjoys learning will acquire more
  education than would be predicted on the basis of
  monetary costs and benefits, and vice versa for
  those who dislike the process of acquiring
  knowledge
• The decision continues to be based on costs and
  benefits but these concepts need to be broadened
  to include non-monetary benefits and costs

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Additional Costs and Benefits from Education

• In addition to increasing ones future earnings,
  education can provide additional future benefits
• Education may open up a more varied and
  interesting set of career opportunities, in which
  case not only the earnings will be higher but
  also the job satisfaction will be higher among
  those with more education

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Additional Costs and Benefits from Education

• The acquisition of knowledge may also alter
  peoples preferences and therefore future
  consumption patterns, possibly enhancing their
  enjoyment of life for a given level of income
• These additional effects of education can be
  incorporated into the theory, but they present a
  challenge for measurement and empirical testing

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Uncertainty and Attitude Toward Risk

• The model abstracts for uncertainty about future
  costs and benefits

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Uncertainty and Attitude Toward Risk

• The returns to education are unlikely to be known
  with certainty
• The investment decisions must be based on
  individuals expectations about the future
• Because some alternatives may be less certain
  than others, attitudes toward risk will also play
  a role

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Uncertainty and Attitude Toward Risk

• Risk-neutral individuals will choose the amount
  of education that maximizes the expected net
  present value of lifetime earnings
• Risk-averse individuals will place more weight on
  expected benefits and costs that are certain than
  those that are uncertain

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Capital Markets

• The model assumes that agents do not confront
  borrowing constraints

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Capital Markets

• Financing is an important aspect of the
  investment decision
• In the case of human capital investments,
  financing is problematic because the individual
  cannot use the future value of human capital
  (i.e., the anticipated future earnings) as
  collateral for the loan

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Capital Markets

• In contrast, physical assets (machinery,
  equipment, land) can be pledged as loan
  collateral
• Therefore, there is a fundamental difference
  between physical and human capital in terms of
  the degree to which perfect capital markets
  prevail

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Capital Markets

• In the absence of subsidized tuition, student
  loan programs, the problems associated with
  financing human capital investment could prevent
  individuals from choosing the amount of education
  that would maximize their Net PV of lifetime
  earnings
• Even under these policies, borrowing constraints
  may influence the decision about investment on
  education

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Asymmetry of Information

• The model abstracts for asymmetry of information
  about innate abilities of workers

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Asymmetry of Information

• If asymmetry of information is included in the
  analysis, the differential in wages for different
  levels of education can be seen as compensation
• To the higher productivity increased by the
  additional education
• To the innate abilities of workers that are
  signaled by the additional education

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Comments on the Role of Education

• We do not expect in real life that education acts
  strictly as a signaling mechanism
• Most educational programs provide some skills and
  knowledge that raise the productivity of workers

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Comments on the Role of Education

• However, it is possible that some forms of
  education or training act primarily as a signal,
  while other forms involve primarily human capital
  acquisition which raises productivity and
  earnings
• In this case, the predictions of one model will
  be more appropriate than the other models
  predictions