Human Capital and Market Size

Abstract

This paper studies how the size of the labour market aff ects workers' decision to invest in human capital. We consider a model of mismatch where firms rank workers according to their level of skills. The matching process operating in the market has the property that the job fi nding probability of workers depends on market size, market tightness and their ranking. An interesting feature is that, while the job finding probability of workers with a given rank di ffers with market size, the probability of workers with a given level of human capital is constant with the size of the market. The model is consistent with several facts highlighted in empirical studies: In bigger markets the distribution of human capital is more unequal and the returns to skill are higher. We fi nd numerically that the mean level of human capital increases with market size.