BENEFITS OF EDUCATION

HIMANSHU SEKHAR ROUT

DEPARTMENT OF A & A ECONOMICS
UTKAL UNIVERSITY, BHUBANESWAR - 751004 INDIA
E-mail: [email protected]
 Types of Benefits of
Education
 T. W. Schultz‟s Views
 General views
 Present and Future
 External
 Option Value
 Intergenerational
 Types of Benefits of
Education: Schultz
 In his outstanding book “The Economic Value of
Education”, T. W. Schultz lists a number of
categories of educational benefits:
– the benefits the economy obtains from educational
research;
– the cultivation and discovery of talents;
– increased “capability of people to adjust to changes in
job opportunities”;
– the preparation of teachers (a self-sustaining
activities‟;
– provision of manpower for sustained economic
growth.
 Types of Benefits of
Education: others
 In addition, schooling provides for:
– better citizenship,
– the ability to appreciate and recognize a wider
range of culture and other services,
– reduces reliance on the market for such
services as the filling of income tax returns,
and
– a chance to give the next generation better
education and, therefore, a better future
 Types of Benefits of
Education: Present & Future
 The benefits that education bestows on an
individual can be classified in to
„consumption‟ and „investment‟.
 A product or service is considered to belong
to the consumption category when it yields
satisfaction (or utility) in a single period
only.
 It would be called a pure investment good (or
service) when it is expected to yield
satisfaction in future periods only.
 Types of Benefits of
Education: Present & Future
 In between we have goods and services that are
both consumption and investment goods, i.e.,
they yield satisfaction now and expect to yield
some satisfaction in the future as well.
 Education is a product that is best characterised
by the „in between‟ classification.
 It yields satisfaction to the student at the time
the education is given and it also provides for
increased utility over time in the form of
increased productivity, greater capacity to enjoy
 Types of Benefits of
Education: External
 Besides consumption and investment benefits, a
host of external effects (third party effects)
amplify the range of educational benefits.
 Such externalities accrue to the student herself,
to her family, her associates, her employer
(present and future), her neighbour, and to
society as a whole.
 Educated person‟s mode of behaviour is likely to
be better in terms of the norms of the society
than that of an uneducated (or less educated).
 Types of Benefits of
Education: External
 Secondly, the student‟s family stands to gain as
well. For example, the mother is relieved of
baby-sitting duties and in the same time she can
go to work or enjoy a range of activities.
 Thirdly, benefit associated with employment
accrue to employer and employee alike. For
example productivity of one employee
influenced other employees and the employer
ultimately.
 Types of Benefits of
Education: External
 Fourthly, the student herself – together with rest
of the community – is quite likely to further
benefit from the educational investment in the
form of lower law-enforcement cost (through less
crime).
 Finally, as Weisbrod suggests, society in general
stands to gain from more education. For
example, the more people who are literate and
educated , the greater the demand for books,
checking accounts. These will lead significant
 Types of Benefits of
Education: Weisbord’s Option Value
 What Weisbord terms the financial option open to
students – completion of one level of schooling
gives the student the opportunity to undertake the
next step in education.
 A second class of option is weisbord‟s non-financial
option. For instance, a college professor has many
non-financial advantages associated with her
position. These include not only the degree of
freedom and flexibility in work, but also the daily
contact with students eager to learn and innovate
the joy of teaching and research and so on.
 Types of Benefits of
Education: Intergenerational Effects
 Parents‟ education directly or indirectly results in
increased educational investment by their
children.
 The alleged intergenerational effects of
education stem mainly from studies showing that
a strong correlation exists between the
educational level of the parents and the
likelihood that their children will embark on
additional educational training as well (Swift and
Weisbord 1965)
 The Measurement of
Educational Benefits
 Four
main approaches put forth by W.
G. Bowen to estimate the value of
education:
– The Simple-Correlation Approach
– The Residual Approach
– The Returns to Education Approach
– The Forecasting Manpower Need
Approach (we are not discussing)
 The Measurement of
Educational Benefits
 The Simple-Correlation Approach: one can
establish that expenditures on education and
national income are closely correlated.
 A positive correlation can be viewed as a
evidence in support of the proposition that
spending money on education is an important
way of raising a country‟s GNP.
 Once again, there is the two-way causation
problem which makes it impossible to give a
satisfactory interpretation to the figures.
 The Measurement of
Educational Benefits
 The Residual Approach: It consists of taking the
total increase in economic output of a country over a
given period of time , identifying as much of the total
increase as possible with measurable inputs (capital
and labour) and then saying that the residual is
attributable to the unspecified inputs (education and
technology).
 Although the residual approach serve an important
purpose , we must fall back on the direct returns to
education approach to get quantitative measure of
educational benefits, which is then used to explain the
 The Measurement of
Educational Benefits
 The Returns to Education Approach: Rate
of Return (ROR) to education can be derived
using one of three basic methodologies.
 When individual earnings data are available
(usually from labour force or household
surveys or population censuses) to construct
age-earnings profiles for each level of
education, the standard discounted cash flow
method (NPV and IRR) can be used.
 Net Present Value (NPV)
 NPV is defined as the difference between
the present value of cash inflows and the
present value of cash outflows.
 Present value of cash flows should be
calculated using appropriate discount rate
(opportunity cost of capital).
 The project should be accepted if NPV is
positive (i.e., NPV > 0).
Net Present Value (NPV)
Net present value should be found
out by subtracting present value of
cash outflows from present value of
cash inflows.
 C1 C2 C3 Cn 
NPV       n 
 C0
 (1  k ) (1  k ) (1  k ) (1  k ) 
2 3

n
Ct
NPV    C0
t 1 (1  k )
t
Calculating Net Present Value
 Assume that for getting primary education, candidate X
costs `2,500 now and is expected to generate return of
cash inflows of `900, `800, `700, `600 and `500 in years
1 through 5. The opportunity cost of the resources
devoted may be assumed to be 10 per cent.
 Rs 900 Rs 800 Rs 700 Rs 600 Rs 500 
NPV    2
 3
 4
 5 
 Rs 2,500
 (1+0.10) (1+0.10) (1+0.10) (1+0.10) (1+0.10) 
NPV  [Rs 900(PVF1, 0.10 ) + Rs 800(PVF2, 0.10 ) + Rs 700(PVF3, 0.10 )
+ Rs 600(PVF4, 0.10 ) + Rs 500(PVF5, 0.10 )]  Rs 2,500
NPV  [Rs 900  0.909 + Rs 800  0.826 + Rs 700  0.751 + Rs 600  0.683
+ Rs 500  0.620]  Rs 2,500
NPV  Rs 2,725  Rs 2,500 = + Rs 225
 Acceptance Rule
 Accept the project when NPV is positive
NPV > 0
 Reject the project when NPV is negative
NPV < 0
 May accept the project when NPV is zero
NPV = 0
 The NPV method can be used to select between
mutually exclusive projects; the one with the
higher NPV should be selected.
 Evaluation of NPV Method
 NPV is most acceptable investment rule for
the following reasons:
– Time value
– Measure of true profitability
– Shareholder value
 Limitations:
– Involved cash flow estimation
– Discount rate difficult to determine
– Mutually exclusive projects
– Ranking of projects
 Internal Rate of Return
 The internal rate of return (IRR) is the rate that
equates the investment outlay with the present
value of cash inflow received after one period.
This also implies that the rate of return is the
discount rate which makes NPV = 0.
C1 C2 C3 Cn
C0     
(1  r ) (1  r ) 2
(1  r ) 3
(1  r ) n
n
Ct
C0  
t 1 (1  r )t
n
Ct

t 1 (1  r ) t
 C0  0
 Calculation of IRR
 Level Cash Flows
– Let us assume that an investment would cost Rs
20,000 and provide annual cash inflow of Rs 5,430
for 6 years.
– The IRR of the investment can be found out as
follows:
NPV  Rs 20,000 + Rs 5,430(PVAF6,r ) = 0
Rs 20,000  Rs 5,430(PVAF6, r )
Rs 20,000
PVAF6, r   3.683
Rs 5,430
22
 Calculation of IRR
 Uneven Cash Flows: Calculating IRR by Trial
and Error
– The approach is to select any discount rate to
compute the present value of cash inflows.
– If the calculated present value of the expected
cash inflow is lower than the present value of cash
outflows, a lower rate should be tried.
– On the other hand, a higher value should be tried if
the present value of inflows is higher than the
present value of outflows. This process will be
repeated unless the net present value becomes
zero.
 Acceptance Rule
 Accept the project when r > k.
 Reject the project when r < k.
 May accept the project when r = k.
 Incase of independent projects, IRR
and NPV rules will give the same
results if the firm has no shortage of
funds.
 Evaluation of IRR Method
 IRR method has following merits:
– Time value
– Profitability measure
– Acceptance rule
– Shareholder value
 IRR method may suffer from:
– Multiple rates
– Mutually exclusive projects
 The Measurement of
Educational Benefits
 The short-cut method: It is employed when the
only earnings data available are average incomes
by level of education. RORs are derived using the
following equation:
rs = ws – ws-1 / ts (cs + ws-1)
 where r, is the rate of return to educational level s
over education level s - 1 as the control group; ws,
and ws-1, are the mean annual salaries of graduates
with s and s - 1 level education respectively; c is the
annual cost per student of educational level s; and t,
is the number of years for educational level s.
 The Measurement of
Educational Benefits
 Mincer‟s Method: The standard Mincerian wage
equation (Mincer, 1974) is
ln wi  0  1si   2 exp i  3 exp   i
2
i

 where, w represents earnings, s is the number of

years of education completed, exp is years of
labour market experience [age – (years of
education+6)], exp2 is experience squared, and
ε is a random disturbance term capturing
unobserved characteristics.
Empirical Results of Returns
to Education
 The four most important patterns are
 The rates of return to education for all levels
of education exceeds generally the
aggregate social opportunity cost of capital.
 The private and social RORs are highest for
primary education and returns decline by
level of schooling . Consequently support for
primary education should be the highest
priority for government and donor agencies.
Empirical Results of Returns
to Education
 The gap between private and social RORs to higher
education is usually considerably higher than the
equivalent gaps for primary and secondary
education. The greater the gap the greater public
subsidization of education. Where it is particularly
large, a strong case can be made for increased cost
recovery.
 The pattern of RORs remains stable as countries
develop with only relatively minor declines in RORs
over time. Thus investment in education continues
to be a very attractive investment opportunity.
 References
 Cohn, Elchanan (1972): The Economics
of Education, Lexington Books, D. C.
Heath and Company, Lexington.
 Bennell, P. (1998): Rates of Return to
Education in Asia: A Review of the
Evidence, Education Economics, 6(2):
107-120.
THANK YOU