A Review of Human Capital Theory: Microeconomics

Abstract

With the beginning of the new millennium it has become more and more apparent that education and human capital constitute a key element of modern economies. Despite the important role of human capital in modern societies, there are still many unknowns about the process of educational production as well as individual and collective decisions concerning how much and what kind of education to obtain. This literature review aims at providing a better understanding of the process of human capital formation and educational attainment. Although human capital plays an important role in both microeconomics and macroeconomics, we focus on the former branch of literature in order to analyze the individual incentives to acquire skills. This review is divided into six parts each of them representing an important stream of human capital literature. First, we introduce the basic concept of human capital that models individuals as investing in skills in response to the expected returns to education. After this, we investigate the different implications of investments in general and specific human capital and then provide an overview of various empirical studies measuring the rate of return to education. Because educational attainment may also be affected by other factors such as school characteristics or family background, we review the literature on educational production functions and discuss the significance of potential inputs into the process of educational production. Subsequently, we refer to models of human capital accumulation over the life-cycle that manage to replicate the empirical life-cycle patterns with respect to the age-earnings profile of individuals. Finally, we analyze the effects of taxation and education subsidies on the formation of human capital.

Keywords: Human Capital, Return to Education, Education Production Function, Life-Cycle of Earnings, Education Subsidies

JEL Classification: H24, H52, I20, I21, I28, J24, J31, J41