The changes in the distribution of earnings during the 1980s have been studied extensively.
The two most striking characteristics of the decade are (a) a large increase in the
college/high school wage gap, and (b) a substantial rise in the variance of wage
residuals. While this second phenomenon is typically implicitly attributed to an
increase in the demand for unobserved skill, most work in this area fails to acknowledge
that this same increase in demand for unobserved skill could drive the evolution
of the measured college premium. In its simplest form, if higher ability individuals
are more likely to attend college, then the increase in the college wage premium
may be due to a increase in the relative demand for high ability workers rather than
an increase in the demand for skills accumulated in college. This paper develops
and estimates a dynamic programming selection model in order to investigate the plausibility
of this explanation. The results are highly suggestive that an increase in the demand
for unobserved ability could play a major role in the growing college premium.