IZA DP No. 1904: Search Equilibrium, Production Parameters and Social Returns to Education: Theory and Estimation
revised version published as 'Search Equilibrium and Social and Private Returns to Education' in: European Economic Review, 2010, 54 (1), 39-59
We introduce different skill groups and production functions into the Burdett-Mortensen equilibrium search model. Supermodularity in the production process leads to a positive intrafirm wage correlation between skill groups. Theory implies that increasing returns to scale can lead to a unimodal earnings density with a decreasing right tail even in the absence of productivity dispersion. Our empirical results indicate economy-wide increasing returns to scale. We use the structural estimates of the production parameters to investigate whether private returns to education equal social returns. Our estimates suggest a positive welfare effect from increasing the share of medium-skilled agents in the workforce.