Economics of Education: Midterm Exam Review & Key Concepts

Posted on Mar 22, 2025 in Naval Architecture

Economics of Education: Midterm Exam Review

Session 1: Course Introduction

Article 1: It’s 2019, Why do 21st century skills still matter?

• Education is shifting as we wrap up two decades of the 21st century.
• Instead of relying on textbooks and teacher direction, these students have to think critically about unfolding events, collaborate with peers and adults, and make creative use of digital tools to communicate their ideas.
• Yesterday’s focus on memorization and rote learning would not prepare students for a fast-changing, increasingly automated, information-saturated world.
• Three phases in the 21st century learning movement: Defining, communication, empowerment.
• 4Cs: communication, collaboration, critical thinking, and creativity.
• The human factor as an aspect: The core skills of collaboration, communication, and critical thinking are things that humans do well and machines not so well.
• Example of 21st century learning by a teacher: The teacher teaches collaboration skills by challenging students to solve mysteries, and then debrief how well they worked together. She fires up students’ communication skills (along with their engagement) by having them interview an astrophysicist about the science of superheroes.
• 21st Century skills that employers look for: Critical thinking, creativity, collaboration, communication, technology, leadership.

Article 2: Why is school reform so hard?

• Under the No Child Left Behind legislation, the federal government is using test scores to identify which schools will face an escalating series of mandatory “reforms.”
• However, these “reform interventions” mandated by the new law have a success rate of well below 50 percent.
• Interventions are uneven in their implementation and always hard to sustain, which is one reason why things don’t work.
• While there are many model schools, model classrooms, and model educators from which we can learn a great deal, there are no model districts, no model states, and no model systems that have put in place and sustained the policies and programs needed to deliver quality education and outcomes to all children.
• This is because of dual character of schools in our society.
• Schools historically have been instruments for reproducing class and race privilege as it exists in the larger society.
• Schools function as a large sifting-and- labeling operation that re-creates and justifies existing distributions of wealth and power. In many ways, schools reproduce the very inequality that American mythology professes they are designed to overcome.
• The dual character of schooling suggests that reforms cannot be judged by their self-proclaimed goals, rhetorical promises, or short-term effect on test scores. Instead, they must be measured by their ability to deliver more democratic classroom experiences and more equitable results and outcomes across the system.
• Small schools a good example of creating a good schooling environment that fosters collaboration.
• Schools have never been just about educating children. They are also about constructing social and political power. Real school reform must be about challenging it.

PPT/Textbook: 1.1-1.3

• The correlation between international test scores and the overall growth rate of the economy as measured by gross domestic product (GDP).

• A 1 standard deviation increase in test scores across countries is associated with a 2% higher rate of GDP growth. ( Why study Econ of Edu? Because Education = Economic growth)
• Formal Education: Education in schools.
• Informal Education: Education in other settings such as home.
• While learning may have intrinsic value for individuals, knowledge and skills (input through education) learned in school may increase an individual’s productivity in the labor market, in turn increasing wages ( output of that education).
• Attainment Vs Skill Development: Getting a degree for the sake of it vs actually learning important skills in school.
• Schooling vs Education: Education can be outside the formal structure of schools. (Add more)
• Positive Economics: Based on facts.
• Normative Economics: Based on values judgements and opinions.
• Equity vs Efficiency Vs Adequacy: While equity involves an equal distribution of resources, efficiency is maximizing overall resources to society.  Adequacy is the quality of these resources being offered.
• Human Capital Theory: Placing economic value on humans based on their productivity. (Becker, Mincer, Schultz)
• Determinants of productivity: Physical capital, human capital, tech knowledge.
• Opportunity cost: Eg: the opportunity cost of studying for this class is the value to you of the other activity you gave up.
• The budget constraint is downward sloping, probably because of opportunity cost.
• To produce skills, schools must make decisions about how to allocate financial resources. This is where the budget constraint comes in.
• Examining tradeoffs – The Budget Constraint : A budget constraint shows all of the attainable combinations of schooling inputs, such as books, computers, and teachers.

• A production possibilities frontier (PPF) shows the combinations of outcomes that are feasible when all available resources are employed.
• Example of a production possibilities frontier:  consider how different allocations of study time will affect your outcomes in English and economics.
• PPF has increasing opportunity cost: The law of increasing opportunity cost is the concept that as you continue to increase production of one good, the opportunity cost of producing that next unit increases.

• Diminishing Marginal Returns: The productivity of a given input declines as additional units of the input are added, holding all other inputs fixed.
• Input Based Policies: Class size, teachers or the offering of certain educational programs.
• Output Based Policies: Policies that promote certain educational outcomes. Eg: No child left behind and its relation to test scores.
• Are Education markets perfectly competitive? No, there are barriers to entry, different institutions price differently etc. Monopolistic competition?
• Does education need reform? Yes, look at the reform article and bring up the 4 C’s.
• Technology in education is both good and bad.

Additional information:

• Watch “Most Likely to Succeed” documentary.
• Refer to Course Introduction powerpoint posted on BB.

Session 2: What are education markets?

Article 1: Positive Externalities and Government Involvement in Education (Hall Article)

• Positive externalities occur when an external benefit is generated by the producer of a good but because there is no market for the externality the producer cannot get compensated for producing this extra benefit.
• Education has two broadly labeled positive externalities:
•  Education increases civic engagement and thereby contributes to a stable and democratic society.
• A stable and democratic society is impossible without a minimum degree of literacy and knowledge on the part of most citizens.
• The gain from the education of a child accrues not only to the child but also to other members of the society.
• Democratic society is impossible without having a common set of values. Minimum education for everyone grants everyone the ability to have common values.
• Negative: Education raises the opportunity cost of an individual’s time, raising the cost of volunteering.
• An educated workforce is vital for the creation and adoption of new technologies which leads to economic growth.
• Education increases not only the productivity of the person being educated but also the productivity of his co-workers.
• If a highly skilled workforce permits entirely different kinds of technologies to be introduced, or to be introduced earlier in a development cycle.
• Education increases voter participation, makes people more aware.
• Inframarginal Externalities: Occur where externalities exist in total but not on the margin. Many people don’t think education falls into this category. For example, if a firm is producing 49 units, marginal cost is the cost of the 50th unit. Inframarginal cost would refer to the cost of units 1,…,49 (usually not with a real number attached).
• Government efficiency vs Market Failure: It is very hard for government to decide how to maximize social welfare, hence the costs are more than the benefits. In addition, a lot of the government’s decisions are political rather than social which doesn’t lead to market efficiency.

Article 2: If Higher education was a public good (Forbes Article)

• Professor holds microphone, giving mass economics lecture to the whole of cambridge via loudspeakers.
• The lecture is for free since Professors words echo a long distance.
• Class size is unlimited, whoever comes to cambridge can listen in for free.
• Higher education can’t be labeled as a public good!
• Public good: A good that is nonexcludable and nonrivalrous.
• Nonexcludable good: Provider cannot charge consumers for the good. Eg: Sidewalks.
• Non Rivalrous good: Enjoyed by many consumers at once where an entry of an additional consumer does not affect the extent to which other people enjoy the good. Eg: Downloading software/music.
• Example of public good: National defense — The US military does not protect me worse simply because it protects you too (Nonrivalrous) and as long as you are in the U.S, the military will protect you whether you pay for it or not.
• Higher education not public good: Universities can force students to pay tuition.
• However, higher education has positive externalities: People who earn college degrees increase own earnings and earnings of people around them. Better-educated workers develop more productive industries which in turn creates more jobs.
• Optimal solution for a good with positive externalities: It can be subsidized by the government to a certain degree. 
• Since social benefits of higher education are finite, and could sometimes have negative externality (credit inflation), Government can’t pay for it fully.
• Also, limited subsidy is good because private benefit of higher education > public benefit of higher education.

Textbook- Chapter 2

• Education markets: The mechanism through which education services are exchanged. (think about supply and demand)
• Demand for education: Families/individuals want education to enhance skills/knowledge.
• Supply for education: Institutions that provide this education for these people.
• Education markets are not perfectly competitive.. There are barriers to entry. In a perfectly competitive market, firms are price takers, and no one firm can alter the price of the good. In education, local schools + public schools + private schools charge differently. Also not perfectly competitive because there is room for inefficiency.
• Education can have spillovers (externalities or neighbourhood effects) that benefit the public.
• Private benefits: Retained by the individual being educated.
• Social Benefits: Benefits absorbed by other members of the society.
• Education a differentiated good: Different by material, style of teaching etc.
• The quality of education one receives can be influenced by the characteristics of other consumers—peer effects.
• Levels of education: Early childhood education, elementary and secondary, postsecondary undergraduate, graduate.

• Providers in education markets: Public (local), Private (profit), Private (non profit).
• Publicly funded means simply that government resources subsidize the provision of education services, with funds awarded either to schools or to students; publicly provided means that the government is charged with resource allocation decisions and the management and delivery of education services themselves.
• Government provides many goods/services that could fit the definition of a public good – but could be restricted. Eg: Roads ( THIS IS QUASI PUBLIC).
• Without externalities, P=MC means that resource allocation is efficient.
• If there are positive externalities, then we need to consider marginal social cost, defined as private marginal cost of production less benefits enjoyed during the production process.

• In the presence of a positive consumption side externality, must consider marginal social benefit, which will be higher than marginal private benefits.
• Internalizing an Externality: The act of making a change in a company’s private costs or benefits in order to make them equal to the company’s social costs or benefits.

Additional information:

• Look at PPT in session 2 and go over Opportunidades and Bolsa Familia.
• Opportunidades is a federal initiative that provides financial resources to families living in extreme poverty for their children’s education, health and nutritional needs.
• Bolsa Familia: Similar to oportunidades. Here the recipients of families with a per capita income of up to $100 a month. Program implemented by Brazil to fight poverty. The program is helping increase children education and reduce child labor.
• Both programs make parents send their children to school in order to receive the benefits. They extend the time students go to school for and the program provides incentives.
• Why should government provide educational services?
• Education markets are characterized by asymmetric information. Students and families do not have enough information about the quality of education. Hence, for-profit providers might take advantage of this and act in their self-interest to earn profits instead of providing good education.
• Efficient production of education requires economies of scale and scope that are difficult to realize with for-profit provision.
• Both government and nonprofit provision of education are ways to subsidize education services, thereby lowering the price and increasing the amount of education people will obtain.
• How does government provide educational services:
• Direct provision.
• Regulation (e.g., resource allocation).
• Provision of funding or subsidies.
• Judicial decisions (e.g., Brown vs. Board of Education, 1954).

Session 3: Human Capital

Article 1: Education and Economic Growth

• It’s not just going to school but learning something while you are there that matters.
• Using average years of schooling as an indicator of a country’s human capital has at least two major drawbacks:
• Approach assumes that students in diverse school systems around the world receive the same educational benefits from a year of schooling.
• This measure does not account for learning that takes place outside the classroom.
• A more direct measure of a country’s human capital is the performance of students on tests in math and science.
• With data being more available now than ever before, it is possible to supplement measures of educational attainment with these more direct measures of cognitive skills.
• Increasing the years of educational attainment. This is because what you learn matters more than just physically average number of years of schooling attained by the labor force boosts the economy only when increased levels of school attainment also boost cognitive skills.
• Tests scores explain economic growth more than being present at school.

Article 2: Education last Century and Economic Growth today

• Why would education in 1900 correlate so well with income today?
• Educated parents and teachers produce educated children. an extra year of school is associated with more than a 30 percent increase in per capita income.
• there are spillovers from education, and that human capital enables places to gain access to better technologies.
• If you work around skilled people, you earn more, either because you have learned from those people or because more skilled entrepreneurs make production more efficient. (More education = more skills= more income)

Class of 27: The documentary

• Children putting food in their backpacks because of lack of food at home on weekends.
• Kids go a long time without eating on weekends, therefore this food keeps them running and fresh Monday morning.
• Families affected in Owsley by drugs. People become drug dealers because of unemployment. Lack of jobs and doing these jobs is easy money.
• Addiction normal for children because they see it all the time.
• 20% students raised by grandparents.
• Grandma example of taking care of kids. Both parents had a drug problem.
• Its about supporting child’s education and making sure that they keep coming to school.
• CONSIDER THE DOCUMENTARY IN THE FORM OF HUMAN CAPITAL FRAMEWORK.

PPT/Textbook Chapter 4:

• Human capital: individuals’ skills that make them productive in the labor market.
• Broader than just education, though education is how many of us invest in human capital. Becker: includes knowledge, skills, ideas, health.
• The human capital model explains the decision to invest in human capital (i.e., skills) that is rewarded with higher future earnings.
• human capital is much more than education. Any personal attribute that increases your productivity is part of your human capital. Eg: LeBron as a high school grad but with attributes to make him an NBA great.
• Human capital comes from several sources, such as the health care system, family environment, and genetic makeup.
• Human capital can’t be sold or lent to anyone, Physical capital can.
• Derived demand: The demand for a factor of production depends on the demand for the finished goods/services it produces. Eg: if the demand for strawberry increases, the demand for strawberry pickers increases too.
• Determinants of resource demand:
• Changes in product demand. (Demand for strawberries).
• Changes in productivity. (How efficiently can strawberry pickers pick).
• Marginal Product of Labor (MPL): the amount that each additional worker contributes to total product.
• Marginal Revenue Product (MRP): the amount of additional revenue a firm earns by adding an additional worker.
• In purely competitive labor markets:    MRPL = MPL x Px.

• The Labor market:
• The price of labor is its wage.
• Assume a purely competitive, price-taking firm in the SR.
• Labor is the variable factor of production.
• The hourly wage is the marginal cost of labor – or here, the marginal resource cost.
• A firm will maximize profits if it hires resources up until the point where MRP = MRC. ( Basically when MRP = wage rate).

• Shifting the Labor Demand Curve:
• Demand for outputs.
• Price of other inputs.
• Quantity of complementary/substitute inputs.
• Technological advancements.
• MP theory of income distribution:
• Income is distributed according to contribution to society’s output.
• Investment model Predictions: Demand for education associated with costs (tuition, foregone earnings etc).
• The outline of the human capital model is simple: Individuals compare benefits in terms of higher wages that accompany greater skills to the costs of educational attainment to determine how much (and what type of) schooling to pursue.

• High school graduates deciding whether or not to go to college likely face much lower foregone earnings.
• Increases in demand for highly skilled labor will increase wages.

• Educational attainment differs based on:
• Personality.
• Benefits gained from education.
• Ability to pay for education.
• Mincers Formulation:
• Assumes that individuals invest in education up to the point where investment costs just equal the present value of schooling gains.
• Predicts earnings as a function of schooling and experience.
• Suggests that earnings are positively related to human capital investments.
• Suggests that higher earnings reflect higher actual productivity.

Session 4: Signaling/Screening

Article 1: In Today’s Economy, How far can a GED take you?

• Every year, roughly 750,000 high school dropouts try to improve their educational and employment prospects by taking the General Educational Development test, or GED, long considered to be the equivalent of a high school diploma.
• The latest research, however, shows that people with GEDs are, in fact, no better off than dropouts when it comes to their chances of getting a good job.
• The things that employers generally most look for or think are important, especially at lower-end jobs, are things like perseverance and tenacity, and those kinds of qualities that are not measured by the GED.
• The GED is better than no credential for a dropout but not as good as a high school diploma.

Article 2: Out of High School, into real life

• Some 30 percent of this year’s three million graduating seniors will not go straight to college, a number that is ticking up as an improving economy draws more graduates directly to work.
• Some simply lack the money for college. Some need to help their families or want to save up for a first apartment.
• Mason Saxton: Knew he did not need to go to college in order to make money, because of past family success.
• Ty Harrington: Ty did not have enough money.

NPR Podcasts:

• Kenny Buchanan – Pennsylvania – 44.
• It’s the eighth job he’s had in the last five years.
• With a wife and two kids, it’s been rough.
• Dropped out of high school in 9th grade, had no interest.
• Was easy to jobs earlier but not now.
• They all ask for a high school diploma. (1/4o million Americans who didn’t graduate).
• Buchanan realized he needed to earn the closest thing to a high school diploma: a GED.
• He believes he has made things better. He got his GED, and he says his friends and family respect him for doing that.

PPT/Textbook- Chapter 5:

• Asymmetric information and the signaling Model:
• Workers ( They have different productivities).
• Employers ( who can identify a workers productivity).
• Workers invest in e when benefits outweigh the costs.
• Let the cost of obtaining e be c/2 for H workers, but c for L workers.
• Let the benefit of obtaining e be 2.
• If the worker does not invest in e, wage = 1.
• Type H workers invest in e if 1(2>
• That is, type H workers invest in e if the net return exceeds the wage without the signal (1).
• Type L workers will not invest in e if the cost exceeds the benefit. They will not obtain e if 1>(2-c) à c>1.
• The signaling theory:
• If going to college is about learning skills, you would assume that your earnings would rise incrementally with the knowledge you gain. However, with signaling its about earning a credential. Eg: We notice that wages increase steeply after obtaining a degree rather than rising incrementally through the process.
• The signaling model equilibrium:
• Separating between high productivity/low productivity based on education.
• Education is a signal of productivity.
• More education means higher pay.
• Employers develop a set of beliefs about how productivity and educational attainment are related.
•  The beliefs are used as a way to set wages as a function of e. Workers will decide whether or not to invest in education as a result of the wage structure set by potential employers.
• Separating Equilibrium:
• Workers will invest in education only when benefits outweigh the costs.
• Separating equilibrium occurs in situations where we can use education as a way to separate L and H workers (or really, a way for them to separate themselves).
• If employers can distinguish between L and H, L workers will get a wage of 1 and H workers will get a wage of 2.
• If they cannot tell them apart, all workers will get paid according to the average MPL:  (1 x p) +((2 x (1-p)) = p + 2 – 2p = 2-p.
• But H workers will want to be paid more to reflect their higher level of productivity.
• They will invest in a signal (e.g., education, abbreviated e) that is intended to express their higher level of productivity.
• Pooling Equilibrium:
• Assume that employers think that workers with e are of type L with probability p and of type H with probability (1-p).
• Then, employers will pay (1xp) +2(1-p) = 2-p to those with e.
• They will pay wage of 1 to workers without e.
• Then, type L workers invest in education if 2-p-c > 1 or, if c1-p,>

Session 5: Estimating returns to education

The College Payoff article:

• This report examines lifetime earnings for all education levels and earnings by occupation, age, race/ethnicity, and gender.
•  a college degree is key to economic opportunity, conferring substantially higher earnings on those with credentials than those without.
• the average lifetime earnings of a Bachelor’s degree holder was $2.7 million (2009 dollars), 75 percent more than that earned by high school graduates in 1999.
•  earnings vary greatly depending on the degree type, age, gender, race/ethnicity, and occupation of an individual. ( Women earn 25% less than men, African American earn less than whites).
• Earnings vary by occupation too — financial managers vs accountants.
• Earning vary within occupation by education level- truck driver with high school diploma earns more than truck driver without.
•  Bachelor’s degree holders earn 31 percent more than workers with an Associate’s degree and 74 percent more than those with just a high school diploma.
• Growth of earnings as you become older is also higher if you obtain a degree than if you don’t.
• No matter how you cut it, more education pays. The data presented here show that there is a sizeable economic return to going to college and earning at least a two- or four-year degree.

Article 2: The Human Capital approach to occupational choice

• The article is comparing physicians and specialists with their cash flows and finances.
• While Physicians require fewer years of education, they do end up earning less than specialists in the long run.
• The chart below illustrates the alternative future cash flows that our hypothetical baseline case implies over the physicians’ careers.

• The red line in the chart represents our hypothetical primary-care physicians and the blue line the specialist.
• the investment here is the primary-care income that the specialists forgo during the extra two years of residency, minus the residency salary they will earn in those two years.
• Notice how the blue line is flat till age 30 and suddenly takes a leap.
• Metrics to evaluate future cash flows from investments are the net present value of the cash flow, known as N.P.V., and the internal rate of return on the decision, known as I.R.R.
• Economists regularly warn against relying on the I.R.R. to evaluate investment decisions, because that metric can be quite treacherous.

PPT/ CH 6 Notes:

• Understanding Educational Investments:
• Education is a good investment if benefits exceed costs.
• Education comes with initial direct and indirect costs, followed by earnings that exceed what would have been earned without the degree.
• Must compare higher earnings in later years with costs incurred initially.
• Present Value:
• We need to adjust the values of payment streams because benefits and costs of education happen at different times.
• If the interest rate (r) is positive, receiving money today is more valuable than receiving money in the future.
• Let t = time period, N = number of years, r=interest rate, Y = payment.
• PV = ∑_(t=1)^N  Y/((1+r)^t).
• If N is large, then PV = Y/r[1- 1/((1+r)^N)].
• Example: A worker with a BA degree in computer science earns $85,000 for a career lasting 43 years. If the interest rate is 5%, what is the PV of this worker’s earnings stream? PV = $85,000/0.05[1- 1/((1+0.05)^43)]=$1,491,402.52 (approx.) ( Refer to PPT).
• Net Present Value:
• Let PV0 represent the PV of earnings if additional education is not undertaken and PVS represent PV of earnings if additional education is undertaken.
• Then NPVS = PVS – PV0.
• We must account for the foregone earnings as well as direct tuition.
• Invest if NPV>0.
• Uses marginal productivity theory (i.e., wages are equivalent to people’s MPLs).
• Predictions based on costs:
• Education tends to increase earnings, implying that the value of earnings foregone rises with more education.
• investment in education “should” occur when people are relatively young so that the NPV of the investment is higher.
• Ability Bias: Imagine that wages are determined by education (E) and ability (A), and that wages have a positive relationship with both characteristic.
• MB of obtaining more education is higher for the higher ability person, leading to higher levels of educational attainment.
• Those of higher ability earn more because the labor market values higher levels of education AND higher ability.