Increasing Returns to Education: Theory and Evidence

We model educational investment and labour supply in a competitive economy with home and market production. Heterogeneous workers are assumed to have different productivities both at home and in the workplace. Following Rosen (1983), we show that there are private increasing returns to education at the labour market participation margin. We show that these depend directly on the elasticity of labour supply with respect to wages. Thus the increasing returns to education problem will be most relevant for women or other types with large enough home productivity. We estimate a three equation recursive model of working hours, wages and years of schooling, and find empirical support for the main predictions of the model.