Why Do College Graduates Earn Higher Wages?

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Why do College Graduates Earn Higher Wages?

In 2007 the typical college graduate earned roughly twice as much as the typical high school graduate. There are two explanations for the college premium. The first explanation is based on supply and demand analysis. A college education provides the skills necessary to enter certain occupations, so a college graduate has more job options than a high-school graduate. Both high-school grads and college grads can fill jobs that require only a high-school education, so the supply of workers for these low-skill jobs is plentiful, and the equilibrium wage for these jobs is low. In contrast, there is a smaller supply of workers for jobs that require a college education, so the wages in these high-skill jobs are higher than the wages for low-skill jobs. This is the learning effect of a college education: College students learn the skills required for certain occupations, increasing their human capital.

The second explanation of the college premium requires a different perspective on college and its role in the labor market. Suppose certain skills are required for a particular job, but an employer cannot determine whether a prospective employee has these skills. For example, most managerial jobs require the employee to manage time efficiently, but it is impossible for an employer to determine whether a prospective employee is a good manager of time. Suppose that these skills are also required to complete a college degree. For example, to get passing grades in all your classes, you must be able to use your time efficiently. When you get a college degree, firms will conclude that you have some of the skills they require, so they may hire you instead of a high-school graduate. This is the signaling effect of a college education: People who complete college provide a signal to employers about their skills. This second explanation suggests that colleges simply provide a testing ground where students can reveal their skills to...
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