Lecture 1
Introduction:
Economics of Education
1
Economics Defined
Scarcity
Choice
Desirability
2
Education Defined
The process of training and developing the
knowledge, skill, mind, character, etc.,
especially by formal schooling.
3
Economics of Education
The study of how society chooses to
employ productive resources to produce
various types of training, develop
knowledge and skills and distribute them.
Production and distribution of skilled human beings.
4
Education as Human Capital
• Education = Investment in human capital & Investment = Risk
• Education is responsible for social and economic development
• Capital deteriorates with inactivity
Creation of Wealth and Education
• Elements in the creation of wealth (labor, physical capital,
technology), are enhanced through education
• Educated workers are more productive
• All areas of resources are refined through education
• Human capital—greater productivity in management
Human Capital
Public sector Private sector
Education
Education: An Important Industry
• Education is the country’s largest industry
• There is a positive relationship between education and economic growth
A Public Sector Responsibility
• Government through taxation produces education services
• Private sector organizations respond to consumer demand
• Education--a political responsibility of government through taxation
• Public education designed to produce equity
Private sector $$$ Public sector
Taxation
• Low end—human effort devoted to essential material goods
• High end—human effort devoted to education and nonessential goods and
services
• As educational services increases, economic productivity and wealth
increases
• Educational system—result and determinant of social and economic
progress
• Education produces non-free services
producer’s good—human capital
consumer’s good—purchaser of education and wants as a
consumer
Stimulates Economic Growth
• Education is important to increases in economic productivity
• The scope of educational services are determined by
government officials
voters’ experiences
school community
taxpayers
those with no direct relationship to education interest group
Total Public Spending on Education
Averages for 1999 – 2004:
Caribbean Countries – 6.5% of GDP
Three East Asian Countries – 4.1% of GDP
Developed Countries – 4.6% of GDP
Used as an indicator of the importance attached
to education (Kendall, 2007)
11
Total Public Spending on Education (2)
Averages for 1999 – 2004:
Caribbean Countries – 16.3% of Gov’t Expenditure
Three East Asian Countries – 18.5% of Gov’t
Expenditure
Developed Countries – 12.9% of Gov’t Expenditure
Used as an indicator of the priority that governments
attach to education (Kendall, 2007)
12
School Enrollment
(% of Gross)
Secondary Tertiary
Caribbean 89 10
Asian Tigers 88 55
Developed Countries 116 62
Source: World Bank, WDI
13
What emerges?
Two challenges:
The need for higher enrollment and
throughput at secondary and tertiary levels.
Delivery of increased output without
increased spending.
(Kendall, 2007)
14
Education as an Industry
481 primary education institutions with
136,374 enrolled
135 secondary education institutions with
107,911 enrolled
86 new sector education institutions with
73,527 enrolled
15
Education as an Industry
8,171 teachers at primary education level
Pupil Teacher Ratio 15.9
7,041 teachers at secondary education level
Pupil Teacher Ratio 14.0
16
Expenditure on Education
FY: 2009-2010
14.1% of budgeted 44.36Bn = 6.27Bn
MoE Allocation = 4.09Bn
MSTTE Allocation = 2.31Bn
17
Expenditure on Education
FY: 2009-2010
MoE Nature of Expenditure
Recurrent 3.37Bn
DP Infrastructure 0.52Bn
DP CF = 0.33Bn
MSTTE Nature of Expenditure
Recurrent 2.07Bn
DP Infrastructure 0.05Bn
DP CF = 0.19Bn
18
Economics of Education:
Primary Concerns
Process of Production
Distributing among competing groups
Allocation of resources to production
19
Production Process
Output
per
Month D
112
C Total Product
At point D, output is
60 maximized.
B
0 1 2 3 4 5 6 7 8 9 10 Labor per Month
20
Production: One Variable Input
Output • Left of E: MP > AP & AP is increasing
per • Right of E: MP < AP & AP is decreasing
Worker • At E: MP = AP & AP is at its maximum
• At 8 units, MP is zero and output is at max`
30
Marginal Product
E
20 Average Product
10
0 1 2 3 4 5 6 7 8 9 10 Labor per Month
21
A Production-Possibility Frontier
C
Government Goods and
B
Services per Year G2
G1 A
0 X2 X1 M
Private Goods and Services per Year
22
The Effect of Technological
Improvement
Moving from A to B to C,
Output
C labor productivity is
increasing over time
100 O3
B
A
O2
50
O1
Labor per
time period
0 1 2 3 4 5 6 7 8 9 10
23
Economics of Education: Major
Issues
Identification and measurement of the
economic value of education
Allocation of resources
Educational planning
Teachers’ salaries, and
Financing education
24
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
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?
Consumption
Value
Benefits
Costs
Undergraduate Master’s PhD
Education
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?
Education as an investment
How do you value a delayed benefit?
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
Return Premium
31
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.
A market for education
Price Supply of places
Total demand
Amount of education
Demand and Supply:
Education Market
Education Economics Reference:
Choice of a Reference Paradigm
Why do we use the economic theories?
Empirical framework: stimulate the research for explanations
for the phenomena studied
Making behavior "predictable" compared to variations of
objective parameters
Forecasts and comparisons made with reliable data
Evaluate “thoroughly" the relevance of alternative
explanations
Economic analysis of the Demand for Education
• Economic theories of education
Education = consumption (preferences, cost, budget)
Education = investment (profitability)
• Education and Growth (early work)
• Education and market productivity
• Education and non-market productivity (health, behavior in
society, ...)
• Beginning of the human capital theory and formalization of the
economic analysis of the demand for education
The Human Capital Theory (1)
The formal analogy with the investment: Education is an investment
that an individual makes to himself in the perspective of future profits
Education costs (direct cost, opportunity cost)
Education provides a sustainable flow of benefits (market and
nonmarket)
Comparing the present value of costs and benefits defines a rate of
return (r)
Σt=0 à n (Bt – Ct)/(1+r)t = 0
Comparison of r for various alternative investments
Rational Choice
Profils « Age-Gains » For 2 Qualifications
Gains
BA
CAPE
18 21 60
Age
Human Capital Theory (2)
The limits of the analogy to physical capital:
Human capital is built in the person
Mobile and non-owned (private)
Dark (reporting strategy, titles, ...)
Varied in its nature
Specific versus general human capital
These characteristics determine the financing of
human capital
The forecasts of the Human capital theory
The return on investment in education is higher when children
enroll early
Marginal Return on investment in education is decreasing
(increasing opportunity cost, low perceiving benefit period)
People prefer the sectors where the return on investment in
education is highest
Diversification of the demand for Education is a function of
individual and contextual parameters that affect return on
investment in education
Urban versus rural
Richest and / or most suited likely invest more than others
Summary
The return on investment in education is positive and is
comparable to that of capital investment
The marginal decrease of return on investment in education is
verified
On average the choice is for sectors where the return is highest
Private and Social Rate of return in Education (%)
Primary Secondary Tertiary
Private Social Private Social Private Social
Africa 37.6 25.4 24.6 18.4 27.8 11.3
Latin America & 26.6 17.4 17.0 12.9 19.5 12.3
the Caribbean
Asie 20.0 16.2 15.8 11.1 18.2 11.0
Europe 13.8 15.6 13.6 9.7 18.8 9.9
OCDE 13.4 8.5 11.3 9.4 11.6 8.5
Alternative Theories to the Human Capital Theory
Human Capital
Education productivity salary
Signal / Filter
productivity Education salary
The paradigm shift does not alter the theoretical forecast at the
individual level
The changes are more important at the collective level and affect in
particular the regulation of the sector
The Supply and Financing of Education
Education: Private good but overall economic effect and
externalities are well considered when measuring the social
returns on investment in education
Justification for public financing of education
Direct Social Returns on Investment in Education
Maximization of Positive Externalities
Likely weaknesses of a management system based mainly on profit
making
The Social Returns and Externalities differ depending on the
level and type of education. The provision of funding for public
education should be adjusted accordingly
Collective efficiency of Education
Education and Salary
Human capital theory
Theory (ies) of the filter
Education productivity and market
Direct analysis in the context of independent activities
Allocative efficiency
Technical efficiency
Education and Growth
Education a growth "factor" (direct or via the Technical Progress)
Education at the origin of adaptive behavior (in a changing
environment)
Education and non-market productivity
Economic theories of education
Returns to education are high (usually> those of physical capital)
Private returns decrease when the level of education rises
For given level of education, private returns decrease with the increase of the
level of development
Social returns follow the same trends and remain high (although they neglect
the possible externalities)
Þ Results justify an investment in important public primary education for
developing countries
Þ Collective investment funding from other levels and types of education must be
flexible and modulated (efficiency / equity)
Þ Favor a pragmatic approach in defining the quantity and quality needs of the
market
Þ Modulation of private and public funding
Education as an investment
Why do the delayed benefits arise?
Two theories:
Human capital theory
Signalling and screening
Human capital theory
What do you understand by the term
‘human capital’
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
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?
Human capital
Link between productivity and wages through
competition in the labour market
Human capital
How does higher education add to a person’s human
capital? What sorts of human capital is it best a
producing?
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?
Human capital
Individuals pay for general human capital, while firms pay
for specific human capital?
Does higher education produce general or specific human
capital?
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
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?
Signalling
Spence (1973):
Suppose that individuals differ in productive capabilities, regardless
of education
Simple case: low ability (100 units per week) and high ability (200
units 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
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.
This is a zero-sum game – if an individual move up the
job queue, it pushes someone else down.
Job competition
Unlike HC 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.
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