Chapter 4 reviews the underlying concepts of human capital theory, including a short introduction to the concepts of demand and supply and the relation between marginal productivity and wages. The first section of the chapter reviews the key assumptions of human capital theory – especially the importance of individual choice, the role of individuals’ initial endowments in making choices regarding investments in education and training, and the causal relation between individual skill acquisition and individual labor productivity. The second and third section of the chapter review some fundamental concepts of supply and demand and the relationship between productivity and wages – these sections are meant for students who have had little or no economics. The final section of the chapter discusses the fundamentals of the model of demand for and supply of human capital – first, in the early model of Becker and Chiswick (1966), followed by the more recent life-cycle investment model as described in Neal (2017). These conceptual foundations allow us to move on to more specific human capital analyses in the next two chapters.
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