Signal-extracting education in an overlapping generations model

In order to get good positions in companies, people try to enter highly-ranked universities. However, abilities vary greatly between individuals. High-ability individuals have an incentive to send signals to firms by obtaining a higher level of education in order to distinguish themselves from low-ability individuals. This paper constructs an overlapping generations model in order to examine the macroeconomic consequences of such sorting behavior of individuals. There are two kinds of possible equilibria in our model. In one equilibrium, only the high-ability agent can obtain higher education and thus an elite society emerges. In the other equilibrium, all ability types have the chance to obtain higher education and thus a society with mass higher education emerges. We also discuss the possibility of multiple equilibria of these different steady states and the dynamic change in wage differentials. Copyright Springer-Verlag Berlin/Heidelberg 2004