Overview
Capital is land and equipment that a firm invests in, in order to generate returns later. By analogy, human capital is an investment made in individuals in the workforce that generates returns later. Most often, it refers to education or training.
Value of Human Capital
The value of human capital can be optimized like most economic decisions. It is characterized by a large up front cost (typically at the beginning of a career, or just prior to it) followed by a return that accrues over the remainder of the life of the individual. The simplest version of this problem has the following variables:
- Lifespan of the Individual {% L %}
- Cost per Year of Education {% C %}
- Benefit per Year, given the years of education {% B(Y) %}
- Number of Years of Education {% Y %}
The cost and benefit can be charted as below. Cost are incurred up front, and the benefits play out over the individuals remaining life.
{% Total \: Benefit = (L - Y) \times B(Y) - C \times Y %}
This function can be optimized by taking the
derivative
with respect to {% Y %} and setting to zero.
(see optiization)
Adjustments
The model given above is a simplification, although it captures the essence of the model and produces a solution in the right ballpark. Some adjustments are needed to get a theoretically correct model. For example, the up front cost occurs early in the process, and so represents a sum of money that could be invested at the prevailing interest rate. The investment returns should be accounted for in the optimization.