February 06, 2003

Should you go to college?

We used going to college as a model for the kinds of investment decisions facing firms. It takes four years to start seeing a return from the investment just as it takes a while to build a factory. The costs are paid up front.

We can think about the investment decision in two ways.
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The calculations for bond yields are complicated enough to pursuade us to use the present value approach for our numerical examples.

Project A and Project B illustrate the point that the rate of return and the present value approaches yield the same conclusion.
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Discounting at 10%, the present value of the benefits is far less than the present value of the costs.
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If we are to justify going to college, we will need to think back to Tuesday's class and invoke the real interest rate concept.

If income grows over time at 1% less than the interest rate, then going to college has a positive net present value.
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These calculations, of course, only measure the private return to education. There is a large positive externality as well. Society benefits from having educated citizens, so much so that the State funds this university.

Posted by bparke at February 6, 2003 05:22 PM