UNIT 4 DEMAND FOR EDUCATIONAL

SERVICES
Structure
4.0 Objectives
4.1 Introduction
4.2 Education as a Public Good
4.3 Nature of Demand for Educational Services
4.3.1 Consumption Good and Investment Good
4.3.2 Private and Social Demand for Education

4.4 Education and Development

4.4.1 Education and the Capability Approach

4.5 Social Demand for Education

4.5.1 Measurement of Costs of Education
4.5.2 Spence’s Theory of Signalling

4.6 Let Us Sum Up

4.7 Key Words
4.8 Suggested References for Further Reading
4.9 Answers/Hints to CYP Exercises

4.0 OBJECTIVES
After reading this unit, you will be able to:
 discuss whether education is a public good or a merit good;
 explain how education is both a ‘consumption good’ and an ‘investment good’;
 describe the role of education in economic and human development;
 explain the concept of the Capability Approach propounded by Sen;
 distinguish between the concepts of ‘private demand’ and ‘social demand’ for
education;
 delineate the concepts behind the measurement of costs of education; and
 state the alternative approach to ‘human capital’ theory by way of Spence’s
theory on signalling.

4.1 INTRODUCTION
Economics of education refers to the application of economic principles in the field of
education. Its scope spreads across several areas of economics (like labour/public/
welfare economics) interfacing with those of ‘theory of economic growth’ and
‘development economics’. Although the importance of education to economic growth
and development was recognised by Adam Smith as early as in 1776, the discipline of
‘economics of education’ emerged as a formal area of study with the work of Theodore 5
Economics of Education W. Schultz around 1960. The central argument of Schultz was that human capital is
basically formed by education and training and it is therefore an important factor of
production. The idea was further developed by Gary Becker (1964) to explain why
individuals invest in education and training in a manner similar to investment in physical
capital. More recent work on endogenous growth theory by Paul Romer (1986),
Robert Lucas (1988), Richard Barro (1999), etc. have demonstrated the contribution
of human capital by relating it to ‘increased productivity’ with the expenditures incurred
on ‘innovation and R & D’. Against this background, the present unit deals with the
issue of demand for educational services with a focus on the concepts of ‘measurement
of costs’ of education.

4.2 EDUCATION AS A PUBLIC GOOD

In the taxonomy of ‘goods’, in the first instance, goods are broadly classifiable into
private and public goods. A private good is defined as a good characterised by rivalry
in ‘consumption’ and excludability in ‘benefits’. This means one person’s consumption
reduces its availability to others and those who do not pay for it can be excluded from
its consumption. A public good, in contrast, is defined as exactly opposite in its
characteristics to a private good i.e. it is non-rivalrous in consumption and non-excludable
in benefits (Samuelson, 1954). But goods satisfying these two characteristics
unconditionally are taken to be ‘pure public good’ (e.g. national defence, light house).
In the Samuelson’s definition, free rider problem remains i.e. non-rivalry leads to none
being excluded and hence all those who consume or draw benefit will not necessarily
pay for it. In view of this, in order to decide whether education is a public good or not
it is essential to go beyond the strict boundaries of a ‘pure public good’.
In the case of education, since it is produced by both government funded as well as by
private funded institutions, in order to decide whether it is a public good or a private
good, we must look beyond the ownership of production and into its market
characteristics. Here, externality is an important feature of education. Consumption of
a good by one person might result in a positive or negative effect (called externality) on
others. Education, besides rendering the private benefits of increased income and
lifestyle to the individual, generates benefits (positive externalities) which spills over to
society. It thus generates societal benefits which is important to be considered by the
government for deciding the extent of its own direct involvement and/or its indirect role
in terms of policy formulation and regulation.
Kaul and Mendoza (2003) argue for an expansion of the definition of pure public good
into two levels. In the first level, any good characterised by its ‘potential’ for either
actually being or desired to being non-rival and non-excludable (like a legislative provision
to be made available to all) is considered. This gives the societal benefit a higher
weightage. Once this is satisfied, as is for education, at the second level a complementary
characteristic on whether the good is ‘de facto public’ is considered i.e. whether the
good is ‘potentially non-exclusive and available for all to consume’ is taken into account.
The distinction is therefore between a good’s ‘potential for being inclusive’and it ‘actually
being inclusive’. Thus, whether a good should be publicly provided or not will not
merely depend on its specific features (like the educated persons being more productive)
but it would also have to be seen from its political and social dimensions. For instance,
the political dimension could be to allow educational institutions to function as ‘corporate
institutions’ (i.e. by allowing them to generate profit as also to create a competitive
atmosphere) and the social dimension, (i.e. considerations of equity), could be to either
allow institutions to function as ‘minority institutions’ or make legislative provision for
6 reservation on socio-economic considerations in admission to both the publicly and
privately funded institutions (both situations as exist in the Indian context). Policies are Demand for
Educational Services
to be so framed that they enhance the availability of such public goods by compensating
for the creation of such goods which the markets may not adequately create by itself
(Marginson, 2007). Neo-classical theory downplays the potential for externalities
and looks to market competition for establishing an equilibrium level for goods demanded
by the consumers ignoring the actual production of most public goods.
In the context of education, for our present purpose, it is useful to dichotomise it into
‘basic education’ and ‘higher education’ [although in its strict sense education consists
of three levels viz. primary, secondary and tertiary where, under ‘tertiary’, both higher
education and vocational and technical education (VTE) are included]. By strictly
adhering to the neo-classical definition of public good, ‘education in general’ qualifies
only as a private good. But keeping in mind the immense positive externalities that
education generates for society as a whole, ‘basic education’ though rivalrous is sought
to be made non-exclusive (by legislations like the RTE Act in India) making the denial
of education an ‘offence’. Thus, basic education is a de facto public good. What is
underlined here is that one has to go beyond the mere ‘publicness’ in the consumption
of a good and examine the two distinguishingly important features essential to have a
complete assessment of the benefits i.e. potential and actual. The term ‘merit good’
coined by Musgrave is important in this context as in the case of ‘basic education’ the
role of state is always very high in view of its high societal benefits as compared to the
private benefits.
Merit Good and Mixed Good: A merit good is a good having positive externalities. In
a free market economy, merit goods are both under-produced and under-consumed
for two main reasons: (i) when consumed, a merit good creates positive externalities
creating a divergence between private benefit and social benefit; and (ii) individuals are
short-term utility maximisers who do not take into account the long term benefits of
consuming a merit good. Therefore, merit goods when produced by private sector
institutions, may not be relied upon to provide adequately to serve the needs of the
community. For instance, while the school education would be considered worthwhile
for being set up by the private sector in urban areas to cater to the needs of the upper
and the middle class population, only the public sector has to assume the responsibility
of catering to its requirement of vast poorer sections of the society. In other words,
merit goods are goods judged as desired to be had by all the individuals in the society
on the basis of a concept of ‘need’ rather than the ‘ability and willingness to pay’. The
concept was originally introduced in the late 1950s by Richard Musgrave who in case
of education argued that those lacking education are incapable of making an informed
choice about the benefits of education thereby warranting a role by the state to provide
the same compulsorily to all sections of society. In later years, higher education came
to be considered a ‘mixed good’ or a ‘quasi-public good’ i.e. essentially a private good
with positive externalities accruing to the society as a whole (Musgrave and Musgrave,
1989 & Marginson, 2007). Mixed goods thus combine the characteristics of both
public and private goods with the market demand being derived as the ‘sum of the
private demand and the social demand’. Bridges and Jonathan (2003) argue that
efficiency conditions should be sidestepped and the importance of societal demand
should be given weightage to regard higher education also as a ‘public good’.
Experience Good/Trust Good: Education is also argued to be an ‘experience good’ as
the true assessment of its quality is feasible only after it is consumed. In other words,
students while undergoing the process of attending and interacting with peers and faculty/
teachers experience and learn such soft skills which they later benefit from while facing
the challenges of job market and society. The uncertainty of benefits from education is 7
Economics of Education rendered further complicated by the information asymmetry inherent in education. In
view of this, Jongbloed (2004) argues that education is like a ‘trust good’ as trust
remains a critical aspect given the asymmetries with which the students have to chose
an educational program and make investment in it with the expectation of deriving a
better income later in life. Stiglitz (2000) regards education as a ‘publicly provided
private good’ because education is both rival and excludable as seats are limited in
educational institutions particularly in privately funded ones. It is also a fact that
depending on the objective and interest of a student (i.e. whether one wants to acquire
education for its own sake – for the sake of knowledge – and not necessarily with the
expectation of future income stream), education is also both a ‘consumption good’ as
well as an ‘investment good’.
Positional Good: In case of goods produced in higher education, outputs like degrees
and certificates might carry a ‘status benefit’ depending on the brand of the institution.
Higher education goods in this sense are ‘positional goods’ as institutions seeking to
improve and raise their status would compete to attract the best students and faculty,
mustering social power in the process. Thus, ‘values’ which are subject to both rivalry
and excludability are generated by private institutions even when similar education might
be provided either entirely free or substantially subsidised by the state (e.g. number of
general under-graduate colleges run by the government in India). However, with the
emergence of free universities (e.g. open access system where course material of a
university is made freely down-loadable) in the market, the concept of ‘open access
knowledge’ is contributing to broadening of access and flattening of social distinctions
thereby enhancing the characteristics of non-rivalry and non-excludability in education.
In other words, higher education is becoming both potentially ‘rivalrous and non-
rivalrous’ as well as both ‘excludable and non-excludable’ i.e. they are interdependent
related in a positive sum fashion. This is pointed out to be the critical difference between
the neo-classical definition of public good and private good.
Global Goods: Outputs of education obtained by cross-border admissions, carrying
the brand of a positional good with individualised status (i.e. foreign degrees), are
classified as ‘global goods’ (Marginson, 2004). Since such degrees are expensive,
they reduce the characteristic of ‘publicness’ by narrowing the size of the beneficiaries.
In view of this, education in the context of globalization, can be called as ‘global public
goods’ defined as being characterised by non-rivalry and non-excludability and broadly
available on a global scale. Besides such degrees, cross-cultural exchanges and activities,
communications and understanding at international levels serve as illustrations for ‘other
public goods’. Stiglitz (1999) argues that such ‘other public goods’ (i.e. other than
formal higher education and research) are examples of ‘global public goods’. In the
current overarching framework of WTO, higher education is treated as a ‘tradable
good’. With multiple government and international agencies involved in such a framework,
Marginson (2004) argues that all autonomous ‘higher education institutions’ (HEIs)
must work towards creation of both public and private goods. The debate on treating
school level of education, due to its enormous benefits to the society, as a merit good
and higher education, due to its nature of being rivalrous in consumption (in view of the
paucity of number of seats in the HEIs) as a mixed/merit/quasi-public good has come
to occupy an important place in the literature on economics of education.

4.3 NATURE OF DEMAND FOR EDUCATIONAL

SERVICES
In an effective sense, demand refers to the choice that individuals make between different
8 goods and services that are available in the market at a given price. The demand for
education also, in a similar way, refers to the desire to participate in education with the Demand for
Educational Services
ability to pay for at least a part of its cost. The latter, besides meeting out the cost by
own resources, could be even in terms of foregoing the opportunity cost of wages lost
by having to attend the school. However, defining demand for education, by applying
the general theory of demand, is not possible as there are some critical issues involved.
First, the demand for education is not merely a relationship between the quantity
demanded and price. Rather, it is a relationship between a complex set of institutions in
the education system on the one hand and the society (with its iniquitous character
among different social groups) on the other. This makes the determining of the price of
education different from determining the price of commodities channelled through the
markets. Second, due to the nature of education being a public (or merit) good, there
could be exclusion of some segments from the education market (i.e. the condition of
non-exclusion required to be satisfied for a pure public good being not uniformly satisfied
across different levels of education). In other words, the earlier view held on education
being a ‘public good’ (on par with national defence, internal security, etc. and exclusively
funded by state) has since changed to quasi-public and even a merit good in view of the
fact that the universal free educational service provided by the government is also limited
in their level and capacity. This is particularly because of the differences in the quality of
education between the public and private sector institutions due to which even families
of low income households may like to send their children to privately managed schools.
Third, to the extent that the production of such goods result in positive externalities, a
few consumers who could afford by virtue of being economically well-off can take
advantage of education without contributing in any way to its production or in terms of
the services to the society. In other words, there would be some free-riders. The two
attributes of externalities and education being a public/merit good means that there is
‘market failure’ leading to divergence between the social and private costs of education
as also in their benefits. Fourthly, to the extent the relationship between education and
society (in terms of benefits) is not one-sided (i.e. the benefits of education would
positively influence society and increase the demand for education due to perceived
individual or private benefits), a situation of ‘endogeneity’ (or simultaneity) arises. All
these factors make the relationship between education and society complex making it
different from conventional goods traded in the market for which the general theory of
demand (applicable to a good where market failure situation is absent) in terms of
variables like price, income and quantity can be applied.

4.3.1 Consumption Good and Investment Good

The question that therefore arises is whether the demand for education is to be analysed
in a consumption or an investment framework. The estimation of demand for educational
services vary depending on whether it is treated as a consumption good or an investment
good. As a consumption good, it provides immediate satisfaction to the consumers,
whereas as an investment good, it helps them in increasing their earnings in future.
Viewed as a consumption good, education is demanded to enhance the human capability
(i.e. to fulfil the necessary functions of leading a normal social life like using public
transport, finding a street address, checking a bill in a restaurant). This approach takes
into account the money costs of enrolment in relation to current tuition charges and
other enrolment costs (taken as a proxy of the price of education). The investment
approach to educational demand considers that an individual will pursue education if
the ‘expected benefits’ from education exceeds the cost of acquiring education. The
expected benefits include lifetime earnings and social and intellectual amenities while
the cost of acquiring education includes expenses in the form of tuition and other fees,
living costs and other incidentals. It also includes opportunity cost measured as the loss
of income incurred by the students while they are in school or college. Hence, the 9
Economics of Education decision to demand education under the investment approach mainly depends on the
expected ‘rate of returns’ to education. It will be demanded so long as the expected
rate of return exceeds the market rate of interest and will be foregone otherwise. In
other words, the demand for education is positively related to the expected rate of
returns and negatively related to the market rate of interest.

4.3.2 Private and Social Demand for Education

Viewed from the consumption or investment frameworks, the demand for education
can be categorised as: (a) individual or private demand and (b) social demand. While
the private demand is defined as the enrolment in an educational system, the social
demand is defined as the aggregate of individual demand (i.e. the total number of persons
enrolled in an educational system). Thus, while the private demand for education is
estimated by the data collected at the household level, the social demand for education
is determined by taking the aggregate data at a state or the country level. For instance,
the study on impact of economic condition on demand for education at individual level
will include the family or household income while at the country level it would include
the National Income. The social demand approach treats education as a service
demanded by the community (just like any other good and service) and regards
educational planning as the process of forecasting demand to establish adequate
institutional arrangement to meet the demand.
Check Your Progress 1 [answer the questions in about 100 words in the space given]
1) Why is ‘externality’ an important feature of education?
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2) What are the two important characteristics of a ‘private good’? For deciding
whether ‘education’ is a public good, why is it necessary to go beyond the definition
of a pure public good?
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3) What is meant by ‘de facto public’? How is the consideration of this complementary
characteristic useful in policy formulation?
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4) Do you agree that ‘basic education’ is de-facto public? Justify your answer.

10 .....................................................................................................................
 ..................................................................................................................... Demand for
Educational Services
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5) Distinguish between the terms ‘merit good’ and ‘mixed or quasi-public good’.
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6) State three reasons as to why ‘education’ is not amenable to the application of the
general theory of demand?
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7) What is meant by endogeneity in the context of demand for education?
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8) What is the underlying thrust in the consumption approach to analysing the demand
for education?
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9) On what basic rationale the investment approach to analysing the demand for
education rests?
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10) What type of data is required to estimate private demand for education? What is
its relation to the data required for estimating the public demand for education?
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Economics of Education .....................................................................................................................
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11) What does ‘educational planning’ basically entail?
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4.4 EDUCATION AND DEVELOPMENT

Investment in education is desired by individuals and also by the State because it is
through education that the individuals not only enhance their productivity but also broaden
their horizon to contribute to the good of the society. Education is demanded for the
holistic development of the economy, which includes not only a rise in incomes through
productivity improvement of individuals but also for removing the inequalities in society,
reducing poverty and hunger, enabling better participation of citizens in their community,
etc. The importance of education for economic growth and development was well
recognised by many classical and neo-classical economists. For instance, Ricardo’s
(1817) work established that increase in economic well-being of the masses is possible
either with a diminution of the population or an augmentation of capital and for both
education is the means to achieve. Malthus (1826) focused on the benefits of limited
family size and for this favoured education as a means of inculcating necessary habits
which would also ultimately lead to economic development. This view was carried
forward by J.S. Mill (1848) to argue that an effective national education of the children
of the labouring class is the first thing needed for the economic development of the
nation. Marshall (1890) too referred to education as a national investment to argue that
the most valuable of all capital is the investment made in the development of human
beings. There was, thus, significant recognition accorded by classical economists to
the subject of economics of education supporting the role of education in promoting
social peace and harmony, self-improvement, and wealth creation. Notwithstanding
these views of early economists, the debate on whether education should be considered
as a sort of consumption continued owing to the argument that limited resources should
be spent on directly productive and growth oriented areas like infrastructure and
therefore the expenditure on crucial social sectors like education and health continued
to be classified under ‘consumption’.
The acceptance that the expenditure incurred on education (and health) amounts to
investment in ‘human capital’ formation came about, as stated in section 4.1 before,
with the human capital theory advanced by Chicago school economists like Schultz &
Jorgenson (1961), Denison (1962), Becker (1964), etc. These economists demonstrated
with empirical evidence that education constituted a key factor in improving the countries’
economic growth and development. In particular, employing the data on national income
for the US economy for the period 1929-58, Denison explained the sources of economic
growth by balancing the factors of production with the total output. His findings revealed
that out of the average annual rate of growth of 3.9 percent, 1.6 percent was accounted
for by capital and 1.0 percent by labour. The residual of 1.3 percent (R) on which he
further focused upon led him to conclude that it is attributable to the quality of workforce
12
(measured for a composite set of factors like ‘health, fitness, experience, skill and
educational attainments’). By breaking up the rate of increase in labour quality into Demand for
Educational Services
three constituents LE, LA and LW (the three standing for educational achievement, changes
in labour quality attributed to age and gender composition and changes due to varying
average work weeks respectively), Denison could deduce that changes in labour quality
accounted for over fifty percent of the annual growth in the residual growth with nearly
forty percent of the change in R, the residual growth, attributable to changes in LE.
Denison’s work was furthered by Jorgenson for the period 1958-73 (and later to 1974-
88) which highlighted the significance of quality of labour to growth. The residual
analysis could not decipher whether the educational levels were profitable at a point of
time from a macro perspective. In other words, the exact margin of benefit for the
individual and the society was not clear. Further, the diversity in specialisation accounting
for varying degrees of economic value generated by the variety of educational
programmes also could not be captured by the residual analysis approach. To overcome
these limitations and to estimate the life time returns on alternative investment in education,
the method of ‘cost benefit analysis’ (CBA) was developed. More recent work by
Romer (1986), Lucas (1988) and Barro (1999) further highlighted the fact that countries
with educated and skilled manpower can have better economic progress as compared
to the countries with less educated people. The mechanism through which education
was considered to influence growth and development was by productivity increases
and generation of externalities. In other words, higher levels of education would be
conducive to higher levels of marginal product in the economy which would further help
to increase the gains in productivity for the whole economy. Amidst this understanding,
the 1990s brought to fore the critique of the role of growth in promoting development
to argue that measuring economic growth in terms of GDP alone does not convey much
about the distribution of income in the society. Although the initial shift from the income-
centric approach to the human development approach started way back in the 1970s
(with the World Bank’s concern on the distributional aspect of income that emphasized
on the need to provide direct provision of public services as complementary strategies
in improving the well-being of the people), it was in the 1990s that the human development
approach took into account the other important dimensions of development like political
freedom, guaranteed human rights and such other ingredients of self-respect. Human
development is, therefore, much more than mere economic development and is
concerned in its approach on people, opportunities and choices. Thus, while the
human capital theory was based on production of skilled workforce achieved through
the medium of education to lead to economic growth, the human development theory
ploughed ahead to identify the essential gaps to be bridged in order to create an
environment in which people can develop their full potential to lead productive and
creative lives in accordance with their own needs and interests. In other words, education
has many externalities like better healthcare, greater community and political participation,
crime reduction and lowered income inequality which were not adequately captured by
the earlier economic approaches to education.
Until mid 20th century, it was assumed that investment in physical capital is adequate to
augment the economic growth and therefore saving and investment in physical capital
was considered the key to economic growth. According to this view, due to diminishing
marginal product of capital, poor countries having low initial physical capital stock can
reap higher rate of return on investment as compared to countries having higher initial
physical capital stock. However, despite this argument, the convergence in growth
rates did not always happen leading to question the theory of investment in only physical
capital as the key to economic growth.
John Kendrick found out that for the U.S. economy, over the period between 1889
and 1957, the combined input (labour and capital) index increased at an average rate 13
Economics of Education of 1.9 percent per annum whereas output index rose by 3.5 percent per annum. Thus,
the remaining 1.6 percent was attributable to all such residual factors not accounted
explicitly. He categorised the residual contribution as a percentage increase in output
per unit of labour input. Later, Robert Solow (1957) attributed the residual growth in
output to technological change, assumed to be exogenous and un-embodied in human
labour.
Schultz (1961) established that the income in the US economy grew at a faster rate
than ‘the amount of land, man hours worked and stock of reproducible capital’ combined
together. He attributed this discrepancy to the improvement in human capacity by
investment made in education. This improvement in human capacity, which he called
human capital, could explain not only the increasing returns to scale in production, but
also the improvements in the inputs, leading to higher economic growth. By increasing
returns to scale here is meant that when individuals invest in their human capital, the rate
of growth in income will be higher than when merely the non-human capital (like land,
man-hours worked and stock of reproducible capital) are employed. Moreover, the
quality of non-human capital also increased when human capital is employed in
conjunction with it. Thus, it was found that it is because of investment in human capital
that many economies could recover speedily from the post world war destruction. It
therefore came to be realised that the difference between the growth rates of any two
economies investing the same amount in non-human capital could be explained by the
difference in their respective investments in human capital.
Edward Denison (1964) estimated the effect of advances in knowledge by subtracting
the rate of growth attributable to all other inputs (besides that of labour and capital)
from the total rate of growth. The exercise helped in isolating the effect of advancement
in knowledge, identified as the contribution from the residual factor, explaining the growth
of output not explained by the two major factors. After the World War II, it was
further confirmed that the investment in physical capital yielded results only in countries
which had qualified men to work upon that physical capital. Western European countries
and Japan are examples of rapid increase in growth rate due to investment in human
capital.
Whereas it is known that investment in education by an individual leads to their better
future income streams, this approach is limited in scope since it focuses only on the
productivity at work or in labour market and not on expanding the substantive freedoms
of individuals. The human capital approach is thus integrated into the concept of
human capability approach by including additionally an element of ‘freedom of choice’
as discussed below.

4.4.1 Education and the Capability Approach

The human capital theory essentially looks into augmenting production possibilities of
individuals through skills, knowledge and effort. The focus is to link the productive
efficiency of individuals, through investment in human capital formation, to their lifetime
earnings. The human capability approach, propounded by Amartya Sen, focuses on
the ability that individuals acquire by choosing to lead a life that they have a reason to
value thereby enhancing the substantive choices available to them.
The difference in the two approaches lies in the scope of abilities that human beings are
considered to acquire as a result of investment in education. The human capital focuses
on the human qualities that also gets employed as capital in production, concomitant to
the way physical capital is employed. This is, however, a narrow view as an educated
person is able to not only enhance his productivity but can also enjoy the freedom to
14 lead different kinds of lives which they have a reason to value. In other words, an
educated person is more than a factor of production because of his ability to make Demand for
Educational Services
informed choices. Thus, investment in education, and through it owing to greater
awareness in health, would enhance the ‘capability’ of individuals. Capability here
refers to alternative combinations of various things, called ‘functionings’, that a person
values and could do. It is a substantive freedom that an individual acquires to perform
various functionings. Thus, education helps enhance human capability, going beyond
one’s labour productivity. Sen explains the role of education in enhancing the capability
of individuals by specifying five important dimensions. The first is its ‘intrinsic’ importance
which can affect effective freedom directly. Second is its ‘instrumental’ importance like
seizing economic opportunities like getting a job and earning which will affect achievement
of other functionings. Third is its ‘social’ role by enabling participation in public discussion
of social needs, informed collective demands for improvement in public delivery of
services and its better utilization, etc. Fourth is its instrumental ‘process’ role such as
by schooling which can reduce child labour, improved social connectivity horizon like
‘campus life’, etc. The fifth dimension is the role of ‘empowerment and distribution’
like resisting exploitation, organizing politically to get a fairer deal both within groups as
well as within family, etc.
As per the human capital approach, investment in education leads to increase in income
through enhancement of factor productivity. However, it is not clear as to how the
increased income translates into enhanced quality of life as increase in income need not
always lead to an enhancement of capability or a substantive freedom for the individual.
Expansion of substantive freedom can therefore be viewed as an end which the
individuals value achieving. For instance, a person prone to illness, despite having
purchased a basket of goods would have less chance of leading a normal life than a
healthy person with a smaller basket of goods. Apart from this, there are: (a)
environmental diversities like variations in climate which influences what a person can
get out of a given level of income; (b) variations in social conditions which affect how a
person converts personal income into enhanced quality of life; (c) unequal distribution
of income within a family; and (d) differences in a relative perspective (i.e. a person
who is relatively poor in a rich community might not be able to take part in the community
life despite the fact that his income is above the income level of many people in the
community). These factors are typically not taken into account in the human capital
approach.
The freedoms are also just not the end but the means for further development. In
order to enhance human capability various instrumental freedoms would be required.
These are: (a) political freedom (i.e. freedom of political expression, opportunities to
determine who would govern the State, possibility to scrutinize and criticize authorities);
(b) economic freedom to utilise the resources like finance; (c) social freedom or
opportunities like provision of educational institutions or health; (d) transparency freedom
or guarantees (i.e. freedom to enjoy the right to disclosure); and (e) protective freedom
or security (i.e. the safety nets provided to reduce the vulnerability and deprivation of
people in society). Thus, since an educated person is better able to exercise these
freedoms than an uneducated person, they can further expand their quality of life. The
freedom which an individual enjoys fuels a person’s overall growth and fosters the
person’s opportunities to have valuable outcomes. It is thus a determinant of an
individual leading a successful life enhancing the person’s ability to not only lead a
meaningful life but also influence the society. Thus, the individual in the human capability
approach is an agent who can act and bring about change, and not just a mere factor
of production, who can enhance their future incomes by investing in education. This
change can thus be a social change going beyond an economic change. For instance,
female education may reduce gender inequality in intra-family distribution by helping to 15
Economics of Education reduce the fertility rates. At a social level, therefore, an educated female can help
create awareness in her community about gender equality and the benefits of a smaller
family. Thus, human capability serves to expand not just economic opportunities (like
in the human capital approach) but can also lead to social development by making
individuals the agents of change.
The above argument is not to say that income is inconsequential to enhance human
capability. Income does help in providing the basic education or healthcare, which
then enhances the substantive freedom of individuals. The various factors enumerated
above explains the difference in the quality of life between individuals with same level
of income. Thus, investment in education has a crucial role in not only enhancing the
personal incomes of individuals but also enhance their capabilities, which the human
capital theory does not capture.
The ‘capability approach’ (CA) proposes that social arrangements should be primarily
evaluated according to the extent of freedom that the people enjoy to achieve what
they value. It is a framework for evaluating and assessing social arrangements in terms
of quality of life and well-being. Sen’s CA is thus a moral framework that aims to
enlarge informational space on the issues influencing the general wellbeing of people. In
a broad sense, it indicates the importance of widening the peoples choices by expanding
the human capabilities. In this framework of development, education is considered
central to the notion of capability and has a much larger role to play for an individual’s
and thereby the societal development. Sen, in this approach, defines human capital as
a means to produce quality human beings through education, learning and skill formation.
In other words, while in the ‘human capital’ approach education is taken as the means
of development, in the ‘human capability approach’ education is itself considered as
development. Sen defines poverty as ‘capability deprivation’ rather than merely a
lowness of income. Education is seen as a valuable functioning, something that is worth
pursuing for its own sake, and is argued to eventually lead to development by enhancing
the quality of life through the freedom of choice. The CA is, thus, built on the dual role
of education viz. (i) an intrinsic value and (ii) an instrumental value i.e. education is
relevant both as a means of economic growth and also to enrich the personal and social
life of people. Sen’s capability approach is criticised on the ground that the widening of
education opportunities need not necessarily lead to an expansion of human capabilities.
The theoretical and empirical works on the capability approach to well-being and
development have several foundational problems that remain to be addressed.
Check Your Progress 2 [answer the questions in about 100 words in the space given]
1) Illustrate the manner in which classical economists emphasised the importance of
education to economic development.
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2) Despite the view on the importance of education, what was the underlying reason
due to which the debate on education continued to be regarded a ‘consumption
good’?
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 ..................................................................................................................... Demand for
Educational Services
.....................................................................................................................
3) How did Denison and Jorgenson succeed in establishing the significance of quality
of labour to growth?
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4) What was the limitation of the methodology adopted by Denison and to overcome
this what alternative approach was developed?
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5) Why did the theory of investment in only physical capital, believed to be adequate
for long, came to be questioned?
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6) What were the contributions of Kenedrick and Solow to understand the contribution
of factors besides labour and capital to output?
.....................................................................................................................
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7) In what way the finding by Schultz (1961) contributed to a more refined way of
understanding the role of investment in education?
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8) State the four factors, not taken into account by the human capital approach,
which goes to determine whether the individuals succeed in translating their income
to enhanced quality of life.
17
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Economics of Education .....................................................................................................................
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9) In enhancing the human capabilities, which other instrumental freedoms are identified
as required for further development of individuals?
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10) State the main proposition of ‘capability approach’ proposed by Sen. On what
ground is this approach criticised?
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4.5 SOCIAL DEMAND FOR EDUCATION

The benefits of education refer to the returns a person or society gets from education.
In practice, it is mainly measured through the earnings or the earning potential of an
individual. Broadly, the benefits of education are categorised as direct and indirect
benefits. The direct benefits include the monetary earnings in terms of wages and
salaries with the average life-time earnings expected to rise with every additional level
of education acquired (e.g. a university graduate is expected to earn more than a
secondary school leaver). The total lifetime earnings of an educated worker can be
assessed through an age-earnings profile. There are also other kinds of financial benefits
which an educated individual enjoys such as by taking up part-time jobs. As these
returns are paid/received through money, it is also known as monetary benefit of
education. Large part of the direct benefits are regarded as ‘private benefits’ as these
mainly benefit the individuals although the society also gets to benefit from educated
persons in some measure. The indirect benefits refer to the positive externalities which
the recipients of education confer upon others in the society. Some of the externalities
include improvement in health of the entire family, reduction in poverty, reduction in
income inequality, better participation of women in community or family decision making,
reduction in crime, etc. These may also include the pleasure derived by the learning
process, the scholastic life led in life later, expected future consumption benefits, etc.
Weisbrod (1962) has categorised the indirect benefits of education into three broad
groups namely, (i) residence-related benefits; (ii) employment-related benefits; and (iii)
societal benefits in general. The residence related benefits are for mothers who can do
some work while their children are at school. Employment-related benefits are the
external effects of one educated worker in the work place on the productivity of other
co-workers. There are some indirect benefits of education which accrue to the society
in general like spreading information favourable to the maintenance of a competitive
economic structure and democratic polity. Although such indirect benefits of education
18 can be recognized, it is difficult to measure them. Further, the extent of indirect benefits
from different levels of education vary widely. For instance, it is expected that the Demand for
Educational Services
parents with higher education can care their children better than the parents with primary
level of education. There are also several external benefits of education (like
neighbourhood benefits) that are not easily quantifiable. Due to the difficulty in measuring
such indirect benefits of education, many researchers consider only the direct financial
benefits. When these externalities are taken into account, the optimal amount of
education that must be provided by the State is greater than what would be provided if
only the private benefits are taken into account. This presents a case for public
subsidisation of education.

4.5.1 Measurement of Costs of Education

In economics, in general, the concept of cost comes into play in the production of
goods or services. The resources used to produce a good or service measured in
monetary terms is known as the ‘cost of the product’. If the measurement is per unit of
service or good, it is known as ‘unit cost’. Estimating the cost of education is useful for
planning the resources required for the education sector. Further, estimation of the
‘rate of returns’ to education helps the government (and households) in deciding whether
to invest in education or not. There is a difference between the cost of education and
expenditure on education. While ‘cost of education’ refers to the value of all inputs
that go into acquiring or imparting education, expenditure on education refers to the
money spent on any item relating to the entire education process.
The costs associated with education are broadly categorised as ‘institutional costs’ and
‘private costs’. The institutional costs (also known as social costs) are the costs involved
in the establishment and running of the educational institutions i.e. the cost of the ‘supply
of education’. The cost of establishment of an educational institution is referred to as
the ‘capital cost’ while the cost of operating it is known as the operational cost or the
‘recurring costs’. For estimating the unit cost of education, both the capital cost and
the recurring costs are taken into account. The recurring costs can be further classified
into two broad heads viz. the direct expenditure and the indirect expenditure. The
direct expenditure refers to the payment towards salaries of teaching and non-teaching
staff (which are institution specific) while the indirect expenditure refers to the money
spent on examining and regulatory bodies necessary for the running of the educational
system. The costs incurred by the households and the students are considered as
‘private cost’ (or individual cost) of education. Private costs are of two types: ‘direct
costs’ which include expenditure on items such as fees, purchasing of books and
stationery, transport, uniforms, accommodation, etc. and the ‘opportunity cost’ refer to
the alternative use of students time in school (since the time of the student cannot be
taken as free). Alternatively, opportunity cost is defined as the earnings that would
have been received had the student chosen not to go for education but to the ‘world of
work’ (i.e. labour market). Likewise, the buildings or the land used for school/college
have alternative uses and in that sense it is also a part of opportunity cost. For instance,
decision to build a school or use a building as school would mean sacrificing its use for
some other purpose. The sum of the costs of education incurred at the individual and
the institutional domains, net of transfers such as fees, scholarships and stipends, is the
‘social cost’ of education.
It is argued that for planning purposes it is sufficient to know only the institutional cost of
education. However, it is equally important to have a clear idea of the private cost of
education as it would help the government in planning for subsidy or scholarship needs.
Moreover, the problems of non-attendance and dropout in school education (in
developing countries) is attributed to ignoring the importance of private costs (e.g.
19
Economics of Education opportunity cost). However, in practice, it is difficult to measure the costs of education
in totality and relatively easy to estimate the private and direct costs as compared to
estimating the social and indirect costs of education. The estimation of costs in the
‘cost-benefit analysis’ approach largely include the private costs ignoring the indirect
and the social costs of education. More specifically, it is difficult to measure the
opportunity cost of education which is the sum of costs foregone by the society and the
individuals. But in some cases, they can be measured with some limitations by considering
proxies. For instance, the opportunity cost of attending higher education can be measured
by taking the average earning of a secondary graduate in the labour market.

4.5.2 Spence’s Theory of Signalling

The returns to education, as per the Becker’s approach to human capital, is viewed
as an input in the production process. The leading alternative, stemming from the work
by Spence (1970), is to view education purely as a signal i.e. a cue to consider education
as a purely screening or signalling device. The rate of returns to education argues that
the higher wage paid to the individuals in the labour market is due to the additional
schooling received which augments the requisite skills and thereby the productivity.
Contrary to this, the theory of signalling argues that the impact of education on increasing
the productivity and income is not due to the skill augmentation, rather, it works as a
screening device to distinguish between high and low productive workers. More
specifically, the screening hypothesis claims that earning differences might be due to the
superior ability of the more educated rather than their additional educational years. In
this sense, attainment in the levels of education reflect certain characteristics (e.g.
diligence, sincerity, and motivation) that are not required in the process of working or
employment but are necessary for educational attainment. Thus, education (or a degree),
or what is often referred to as ‘credentials’, acts as a screening device that helps the
employers to differentiate between the more able workers from the less able workers.
Such screening in the job market through education is useful because the employers
(the buyers of labour services) cannot assess the true quality of the sellers of labour
services (technically known as information asymmetry in the job market and is considered
as a source of market failure). Though there is as yet a lack of empirical evidence on
the screening theory in the literature on the economics of education, it is nevertheless
viewed as a contribution in extension to the human capital theory.
Check Your Progress 3 [answer the questions in about 100 words in the space given]
1) State the three groups into which Weisbrod categorised the ‘indirect benefits’ of
education giving some illustrations, in particular, for the ‘societal benefits’.
.....................................................................................................................
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.....................................................................................................................
2) Distinguish between: (i) the ‘cost of education’ and the ‘expenditure on education’;
and (ii) ‘capital cost’ and the ‘recurring cost’ of education.
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20
 ..................................................................................................................... Demand for
Educational Services
3) How is ‘opportunity cost’ defined? How is it measured in education sector? Can
certain type of ‘capital cost’ be considered as ‘opportunity cost’? Why?
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4) What does the Spence’s ‘screening hypothesis’ basically claim? What does it
signify? In what way it is helpful?
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4.6 LET US SUM UP

The unit has addressed the issue of ‘demand for educational services’ from the standpoint
of costs, expenditure and measurement dimensions. Beginning with a conceptual
discussion on the classification of educational services as a public or private good, the
account furnished in this respect proceeds to bring out the various alternative forms of
‘goods’ in terms of which also ‘education’ has since come to be viewed. The unit then
discusses the contributions of different theorists which progressively led to the acceptance
of education as an important component of enhancing the economic growth and thereby
the human development of a country from a much more comprehensive sense than was
earlier understood. The unit then defines various concepts like private/social cost, capital/
recurring cost, institutional/opportunity cost and direct/indirect benefits helpful in
measuring and thereby assisting the planners in providing for the required resources
and policy framework for meeting the demand for educational services. An alternative
theory of the use of education as a ‘signalling’ device, mainly to assist the employers in
the labour market to distinguish between the quality of job seekers is finally outlined.

4.7 KEY WORDS

Benefits of Education : refers to the returns a person or society gets from
acquiring education. In the economics of
education literature, the benefits of education is
measured through the earning potential or power
of an individual. This is an incomplete measure
as most of the externalities of education occurs
outside the market. Broadly, the benefits of
education are categorised as direct benefits and
indirect benefits. Direct benefits include the
monetary earnings in terms of wages and salaries
while indirect benefits include the pleasure derived
from the learning process, scholastic life, future
consumption benefits, etc.
21
Economics of Education Cost Benefit Analysis (CBA) : Is a technique that determines the relative merits
of alternative investment of scarce resources by
assessing the costs and benefits associated with
the projects/schemes under consideration.
Human Capital : Human capital refers to outcome of learning,
skills, knowledge, etc. which remains embodied
in an individual and manifests in the form of
augmentation of productivity of individuals in their
working and social life. The theory of human
capital treats education as an investment in man
and suggests that individuals and society gain
substantial economic benefits from the people
with education and skills.
Returns to Education : In the human capital theory the expenditure made
on education is treated as investment and it is
comparable with the investment done in any other
physical capital. Its estimation procedures takes
into account the costs and benefits of education
to determine whether it is worthwhile to invest in
education or not. The estimation of the returns
to education has a range of limitations particularly
in the methods and techniques used in its
calculation.

4.8 SUGGESTED REFERENCES FOR FURTHER

READING
Becker, Gary S. (1975), Human Capital: A Theoretical and Empirical Analysis,
with Special Reference to Education. New York: Columbia University Press.
Saumen Chattopadhyay (2012), ‘Economics as a Public Good’ (Chapter 6) in Education
and Economics: Disciplinary Evolution and Policy Discourse, Oxford University Press.
Details of references cited in Section 4.2 are available in this Chapter.
.................................... (2014), Education for Development: An Exploration of the
Linkages in the Indian Context, Trade and Development Review, Volume 6, Issue 2,
pp 51-71 (http://www.tdrju.net).
Psacharopoulos, G. (1994), Returns to Investment in Education: A Global Update,
World Development, 22 (9): 1325-43.
Woodhall, M. (2004), Cost-Benefit Analysis in Educational Planning (4th ed). Paris:
UNESCO, IIEP.

4.9 ANSWERS/HINTS TO CYP EXERCISES

Check Your Progress 1
1) See 4.2 and answer.
2) See 4.2 and answer.
3) See 4.2 and answer.
22
4) See 4.2 and answer. Demand for
Educational Services
5) See 4.2 and answer.
6) See 4.3 and answer.
7) See 4.3 and answer.
8) See 4.3.1 and answer.
9) See 4.3.1 and answer.
10) See 4.3.2 and answer.
11) See 4.3.2 and answer.
Check Your Progress 2
1) See 4.4 and answer.
2) See 4.4 and answer.
3) See 4.4 and answer.
4) See 4.4 and answer.
5) See 4.4 and answer.
6) See 4.4 and answer.
7) See 4.4 and answer.
8) See 4.4.1 and answer.
9) See 4.4.1 and answer.
10) See 4.4.1 and answer.
Check Your Progress 3
1) See 4.5 and answer.
2) See 4.5.1 and answer.
3) See 4.5.1 and answer.
4) See 4.5.2 and answer.

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