[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

EDUCATION AND ECONOMIC TRADE-OFFS
The production possibilities curve introduced in Chapter 2 can illustrate how
decisions concerning investments in human capital are made. To accomplish this,
we divide an individual’s life into two periods: “youth” and “later working years.”
Figure 9.6 depicts the relationship between consumption in youth and in later
life. As the individual gives up consumption in his youth, staying in school longer
increases his expected future consumption because he can expect his income to
go up. The curve has been drawn with a rounded shape. It shows diminishing
returns: spending more on education today (reducing consumption) raises future
income, but each additional investment in education provides a smaller and
smaller return.
Point A represents the case in which Everett is a full-time student through four
years of college, with little income until graduation (his youth) but with a high income
in later life. Point B represents the consequences of dropping out of school after
high school. When he does this, Everett has a higher income in his youth but a lower
income in later life. Other possible points between A and B represent cases where
Everett drops out of college after one or two years.
The Basic Competitive Model
CONSUMPTION AS ADULT
Figure 9.6
A
Consumption
possibilities
curve
B
CONSUMPTION IN YOUTH
EDUCATION AND THE TRADE-OFF
BETWEEN CURRENT AND FUTURE
CONSUMPTION
Point A represents a choice of a reduced consumption
and better education in the present,
with a higher consumption in the future. Point B
represents the choice of higher consumption
and less education now, with a lower level of
consumption in the future.
We now have completed our description of the basic competitive model.
Households make decisions about how much to consume and what goods
to purchase. They decide how much labor to supply and how much to save.
The firm in the competitive model takes the price it receives for the goods
it sells as given. The firm also takes the prices of the inputs it uses, including
the wages it pays workers and the cost of capital goods, as given.
At these prices, the firm chooses its outputs and inputs to maximize
profits. Prices adjust to ensure that demand and supply are equal. In the
labor market, wages bring demand and supply into balance; in the capital
market, the interest rate is the “price” that adjusts to balance supply
and demand.
We have now seen where the supply and demand curves that were introduced
in Chapters 3 and 4 come from, and why they have the shapes they do.
Whether we examine the household’s demand for goods, its supply of labor,
or its savings decision, the effects of price changes on the household’s choices
can be analyzed in terms of income and substitution effects. We also demonstrated
that firms balance marginal cost and price in deciding on production
levels, and they set the value of the marginal product equal to the price of an
input in deciding on their demand for factors of production such as labor and
capital. An increase in the real wage reduces the firm’s demand for labor.
An increase in the interest rate reduces the demand for capital. In the
next chapter, we will put all these results together to sketch a model of the
complete economy.
206 ∂ CHAPTER 9 CAPITAL MARKETS