Introduction

The life-cycle model concerns individual investment decisions. It forms the core of human capital theory which deals with the acquisition of earnings power so crucial to understanding earnings differences. In this chapter we concentrate on two earnings patterns. The first pattern is that earnings rise with age, but at a diminishing rate so that younger workers' wages rise more quickly than older workers' wages. The second pattern is that earnings rise with education so that college graduates earn more than high school graduates, and in turn high school graduates earn more than primary school graduates. These observations are prevalent in data not only for the US and England, but also for all countries for which earnings data are available. The two patterns are universal and hence worthy of an explanation.

The chapter sets the stage by presenting statistical evidence. It then explores the life-cycle human capital model graphically, and ends by depicting the model algebraically.

The age–earnings profile

Earnings generally rise with age at a decreasing rate. This can be illustrated graphically in what is called an age–earnings profile as shown in figure 2.1. Typically age or labourforce experience is measured along the horizontal axis, and earnings along the vertical axis.