Development Economics X Paper Model Twenty-Five
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This paper examines the effects of grade inflation on the Spence signaling model of education. We consider two scenarios: one where employers are informed about the grade inflation and adjust their beliefs accordingly, and another where employers are uninformed and base their beliefs on the historical distribution of grades. We show that in both scenarios, grade inflation reduces the signaling value of education and leads to either a higher or a lower separating equilibrium, depending on the degree of grade inflation and the cost function of education. We also show that grade inflation lowers the social welfare and the expected utility of both types of workers. We then extend the model to a setting where only a fraction of educational institutions inflate their grades, and compare the outcomes under informed and uninformed employers. We find that the presence of grade inflation creates a distortion in the market for education, and that the informed employers can mitigate this distortion by offering a premium to the graduates from the non-inflating institutions.
Opoku-Agyemang, Kweku (2024). "The Effects of Grade Inflation on Signaling in College Education." Development Economics Paper Model Twenty-Five.
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