4.7. Human capital theory Just as firms invest in K, the i’s will invest in Hk (education, training, etc.) Data reveal: 1.Spending in education and training is important 2.Educational achievements have increased in recent years 3.Investment in education results in higher income A. Smith  coins Hk term Other (Mincer, Schultz, Becker) “model” the idea

4.7. Human capital theory Every expenditure which implies an increase of future productivity levels is an investment When an additional year of education is a good investment? when the additional benefits > initial costs The rate of return should be at least as equal as other alternatives Direct costs: fees, books, etc. Indirect costs (opportunity costs): what people left aside (stop earning) to attend college; usually higher than the direct costs Financial benefits: income that graduate people get in the JM

5. The determination of wages 5.1. Competitive labor market and law of one wage A D L and a S L interacting and determining W and L Hypotheses: 1.Firms max. π and workers U 2.Large no. of firms competing for L 3.Workers  same productivity or skill 4.Firms and workers are wage-takers (no unions) 5.Perfect information and mobility Given 1-5, it yields “law of one wage” (law of one price)

5.1. Law of one wage The law of one wage describes a long run situation, that is, one of equilibrium Markets though are in constant change, so the law does not always stand Further, the hypotheses from the competitive model might not be true in reality  market imperfections The more serious the imperfection the farther the result from that of perfect competition

5.2. Labor market imperfections 1.Non-maximizing behavior Principal-agent 2.Imperfect information “Job search” 3.Heterogeneity of workers and jobs 4.Collusion 5.Mobility costs In competition  one wage for every labor market Imperfections  dispersion of W (area of indeterminacy)

5.2. Labor market imperfections For some economists, a more realistic model would show an area of indeterminacy  dispersion of W for same L (it can be shown graphically) Indeterminacy  allows certain discretion to firms In perfect competition, however, markets “clear” or remain in equilibrium But, this equilibrium can be altered when the S L and D L curves change (shifts)

5.2. Labor market imperfections S L = g(w, Q)  Q = Q(Y NL, Pref L-l, W i, C NW, n …) (+) (-) (+/-) (-) (+) (+) D L = f(w, Z)  Z = Z(D c, py, p i, m, tax …) (-) (+) (+) (+/-) (+) (-) Examples: a.What happens when py and W i (wages in other occupations) go up, and both are equally-sized changes? b.What happens when D c goes down and C NW goes up but the fall in the former is more pronounced than the increase in the latter? c.What happens when py goes down and there is an epidemic that kills many people, and both are equally-sized changes? d.What happens when the no. of firms increases and the Y NL does so but to a larger extent?