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Wages and Employment: The Canonical Model Revisited

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Abstract

The basic canonical model fails to predict the aggregate college premium outside of the original sample period (1963-1987) or to account for the observed deviations in college premia for younger vs. older workers. This paper documents that these failings are due to mis-measurement of the relevant prices and quantities when using composition adjustment methods to construct relative skill prices and supplies, which ignore cohort effects that are particularly important in the 1980s and 1990s. Re-estimating the model with prices and quantities that incorporate cohort effects produces a good fit for the out of sample prediction and explains the observed deviation in the college premium for younger vs. older workers even with perfect substitutability across age. Moreover, the estimated elasticity of substitution between high and low skill is higher and there is a much smaller role for SBTC in explaining the path of the college wage premium. The elasticity of substitution is also an important parameter for the broader literature on education and wages, especially in assessing general equilibrium responses to government policies. In the case of a tuition subsidy, price responses can undo most of the direct (partial equilibrium) effect of the subsidy on enrolment, so that general equilibrium enrolment responses are substantially weaker. The higher elasticity estimated in this paper, produces much weaker general equilibrium relative price changes and stronger enrolment effects.

Suggested Citation

  • Audra J. Bowlus & Eda Bozkurt & Lance Lochner, 2017. "Wages and Employment: The Canonical Model Revisited," University of Western Ontario, Centre for Human Capital and Productivity (CHCP) Working Papers 20179, University of Western Ontario, Centre for Human Capital and Productivity (CHCP).
  • Handle: RePEc:uwo:hcuwoc:20179
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    1. Thomas Dohmen & Armin Falk, 2010. "You Get What You Pay For: Incentives and Selection in the Education System," Economic Journal, Royal Economic Society, vol. 120(546), pages 256-271, August.
    2. Patrick Bolton & Mathias Dewatripont, 2005. "Contract Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262025760, October.
    3. Brant Abbott & Giovanni Gallipoli & Costas Meghir & Giovanni L. Violante, 2013. "Education Policy and Intergenerational Transfers in Equilibrium," Working Paper series 15_13, Rimini Centre for Economic Analysis.
    4. repec:nbr:nberch:13979 is not listed on IDEAS
    5. David Card & Thomas Lemieux, 2001. "Can Falling Supply Explain the Rising Return to College for Younger Men? A Cohort-Based Analysis," The Quarterly Journal of Economics, Oxford University Press, vol. 116(2), pages 705-746.
    6. Heckman, James J & Lochner, Lance & Taber, Christopher, 1998. "General-Equilibrium Treatment Effects: A Study of Tuition Policy," American Economic Review, American Economic Association, vol. 88(2), pages 381-386, May.
    7. Scott A. Imberman & Michael F. Lovenheim, 2015. "Incentive Strength and Teacher Productivity: Evidence from a Group-Based Teacher Incentive Pay System," The Review of Economics and Statistics, MIT Press, vol. 97(2), pages 364-386, May.
    8. Audra J. Bowlus & Chris Robinson, 2012. "Human Capital Prices, Productivity, and Growth," American Economic Review, American Economic Association, vol. 102(7), pages 3483-3515, December.
    9. Thomas Lemieux, 2006. "Increasing Residual Wage Inequality: Composition Effects, Noisy Data, or Rising Demand for Skill?," American Economic Review, American Economic Association, vol. 96(3), pages 461-498, June.
    10. Audra Bowlus & Haoming Liu & Chris Robinson, 2016. "Different Paths? Human Capital Prices, Wages and Inequality in Canada and the US," NBER Chapters,in: Public Policies in Canada and the United States National Bureau of Economic Research, Inc.
    11. James Heckman & Lance Lochner & Christopher Taber, 1998. "Explaining Rising Wage Inequality: Explanations With A Dynamic General Equilibrium Model of Labor Earnings With Heterogeneous Agents," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(1), pages 1-58, January.
    12. David Deming & Susan Dynarski, 2009. "Into College, Out of Poverty? Policies to Increase the Postsecondary Attainment of the Poor," NBER Working Papers 15387, National Bureau of Economic Research, Inc.
    13. Christopher Avery & Sarah Turner, 2012. "Student Loans: Do College Students Borrow Too Much--Or Not Enough?," Journal of Economic Perspectives, American Economic Association, vol. 26(1), pages 165-192, Winter.
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    JEL classification:

    • J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials

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