N6

Some MPs believe that there is a causal relationship between earnings and years of schooling. They show you an estimate of the impact of years of schooling on annual earnings: There are two groups of individuals - group 1 and group 2. Group 1 on average earns 60,000 per year with the average level of post-compulsory education of 6 years, while group 2 earns on average 40,000 with the average post-compulsory education of 4 years. The MPs conclude that the annual return to an additional year of education is 25% using the following equation [(60,000-40,000)/40,000]/(6-4)=25%. Ignoring time preferences and discounting, and if both groups face the same cost of schooling, you need to explain to the MPs why this is not a good estimate of the annual return to an additional year of education. Propose methods to the MPs to deal with the problem.