Imperfect Information, Self-Selection, and the Market for Higher Education

Abstract

This paper explores how the steady trends in increasing tuition costs, college enrollment, and the college wage gap might be related to the quality of college graduates. The model shows that the signaling role of education might be an important yet largely neglected in-gredient in these recent changes. I develop a special signaling model in which workers of heterogeneous abilities face the same costs, yet a larger proportion of able individuals self-select to attend college since they are more likely to get higher returns. With imperfect information, the skill premium is an outcome which depends on the equilibrium quality of college attendees and non attendees. Incorporating a production function of college edu-cation, I discuss the properties of the college market equilibrium. A skill-biased technical change directly decreases self-selection into college, but the general equilibrium effect may overturn the direct decline, since increased enrollment and rising tuition costs increase self-selection. Higher initial human capital has an external effect on subsequent investment in school: All agents increase their education, and the higher equilibrium tuition costs increase self-selection and the college premium. JEL codes: J24, I21, J31 * Email tali.regev@sf.frb.org. I am grateful to my advisors Daron Acemoglu and Ivan Werning for their helpful suggestions and support. I also thank