Occupational Choice under Uncertainty

An econometric problem in estimating models of occupational choice is that the agents' forecasts of future wages and occupational tenure are unobservable. This paper solves the problem by assuming that agents have rational expectations and by considering the effects of arbitrage both within and between cohorts. The solution consists of two time series regressions of the demand and supply functions of entrants into an occupation. From these regressions one obtains estimates of the rate of return to education, the direct cost of education, and other parameters that influence the market. The model was estimated with data from the market for lawyers. 1. MANY OCCUPATIONS REQUIRE the agent to acquire some schooling before he can practice. How does the agent choose between two occupations that require different schooling periods? Since Adam Smith [17, Book I: Chapter 10], economists have assumed that the agent decides by comparing the expected present value of incomes between the two occupations (e.g., Friedman and Kuznets [7], Schultz [15], Becker [1], and Mincer [10]; see [13] for a survey of the literature). While the decision rule is well known, the problem of uncertain wages plagues empirical applications of models embodying the decision rule. Most empirical works rely on cross-section data or short panel data sets. Thus the total wages over the lifetime of the agent are not observed. "The question of ex ante expectations cannot of course be known. Short term macroeconomic factors tend to confound estimates of costs and returns to education" (Rosen [13]). Rosen also raised the question of dropouts. That is, agents may leave an occupation in which they practiced. Therefore the question of uncertain wages is complicated by the additional uncertainty of occupational tenure. There was an important attempt to solve the problem of uncertain wages by Richard Freeman [3, 4, 5]. Freeman recognized that demand conditions in the market affected the supply of new students. He argued that new entrants made their decisions to enter by comparing current wages in the relevant occupations. Since future conditions may change, current wages may not be good predictors of future wages. These systematic forecast errors lead to cycles in the supply of new entrants; these cyclical models are known as Cobweb models. This paper also considers the problem of occupational choice under uncertainty. An agent's decision problem based on maximizing expected discounted value of income is explicitly solved. The result is a generalization of Mincer's schooling model [10]. I also close the model by positing a demand curve for the