DOES HIGHER EDUCATION pay? Yes, it does: in the modern economy, employers are willing to pay a premium for workers with more education. And the size of that premium has increased a lot over the last few decades. In 2013, Americans with four-year college degrees made 98% more per hour on average than those without a degree. That percentage is up from 89% in 2008, 85% in 2003, and 64% in the early 1980s. In fact, according to David Autor, a professor of economics at MIT, the true cost of a college degree is approximately negative $500,000. That is, a college degree is cheaper than free. In other words, not getting a college degree will cost you about half a million dollars over your lifetime. That’s roughly double what the negative cost was 30 years ago. And because having a bachelor’s degree is so valuable, more Americans than ever are getting one: in 2013, 34.5% of those aged 25 to 29 had at least a bachelor’s degree, compared to 24.7% in 1995.
Who decided that the wages of workers with a four-year college degree would be so much more than for workers without one? The answer, of course, is that nobody decided it. Wage rates are prices, the prices of different kinds of labor; and they are decided, like other prices, by supply and demand.
Still, there is a qualitative difference between the wage rate of high school grads and the price of used textbooks: the wage rate isn’t the price of a good, it’s the price of a factor of production. And although markets for factors of production are in many ways similar to those for goods, there are also some important differences.
In this chapter, we examine factor markets, the markets in which the factors of production such as labor, land, and capital are traded. Factor markets, like markets for goods and services, play a crucial role in the economy: they allocate productive resources to producers and help ensure that those resources are used efficiently.
This chapter begins by describing the major factors of production and the demand for factors of production, which leads to a crucial insight: the marginal productivity theory of income distribution. We then consider some challenges to the marginal productivity theory and examine the markets for capital and for land. The chapter concludes with a discussion of the supply of the most important factor, labor.