Measuring Human Capital Returns

Abstract

The correct measure of the return on human capital investment is the wealth effect of the wage increase which the investment makes possible. A geometric model of this investment decision is examined. The currently pervasive "income difference" measure is shown to contain an upward bias positively related to the size of the investment. Alternative tests for "shortage" and "surplus" conditions are developed which correct for this bias. It is shown that labor supply schedules may bend backward only when the relevant wage changes are incorrectly anticipated. It also is shown that among individuals who differ only in wealth, those with less wealth will elect to invest in human capital at lower wage levels in the relevant employments.