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ECON 139 set 7 (16 pages)

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ECON 139 set 7


Lecture number:
Lecture Note
University of California, San Diego
Econ 139 - Labor Economics

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Page 1 of 16 May 12th 2015 Do Workers Maximize Lifetime Earnings? • If we solve the ability bias problem, we can learn the return to schooling (on average by how much do earnings increase when schooling increases by 1 year). • However, this doesn’t tell us whether any given individual’s choices are optimal because of selection bias. • The idea of selection bias is that there is heterogeneity in the returns to a college degree. • And, it’s never possible to observe an individual’s returns since you never observe what he/she would have earned if he/she had made a different education choice. Selection Bias • For example, suppose ability is multidimensional. – Paul is a good plumber, but would make a lousy manager. – Marvin is a good manager, but would make a lousy plumber. – You need a college degree to be a manager but not a plumber. • Suppose that Marvin goes to college, but Paul does not. • Did they each make the right educational choice? ECON 139 SP 15 Antonovics 7 5-­‐12-­‐15 1 Page 2 of 16 • Observed college wage differential=WM-WP - Understates wage gain for Marvin - Overstates wage gain for Paul - Both may be making the right schooling choice, but it’s hard to know using the observed college wage differential. • In the model we just examined, workers who were relatively good at one type of job were relatively bad at the other type of job. • Contrast this with ability bias in which ability is one - dimensional. • Empirical work that attempts to correct for selection bias tends to find that people do make the right educational decisions. Social Standpoint • How much education is optimal from a social standpoint? • Concern motivated by 3 observations: 1. American workers are facing increasing competition from workers in other countries. 2. New technologies have increased the demand for workers with high levels of cognitive ability. 3. Although Americans spend as much per pupil as other industrialized countries on education, American students consistently score below students in other countries. Why Does Schooling Increase Wages? Two main theories: 1. Human capital theory: individuals acquire valuable human capital at school. -- Acquire useful skills at school 2. Signaling theory: schooling signals to employers that workers are more productive -- Employers need to know you are hardworking and determined, prove to the employers that you are able to suffer the 4 years in college Page 3 of 16 However, if it comes to what the government subsidy had helped, think of the first theory. The Signaling Model (Spence) • Two types of workers – High-ability workers: MP = 2 – Low-ability workers: MP = 1 High-ability worker twice productive than low-ability workers • Employers cannot observe worker’s type. • Education is less costly for high-ability workers – High-ability workers: c = e/2 – Low-ability workers: c = e High-ability worker twice less costly than low-ability workers • Let PVE denote the present discounted value of ...

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