The ability of firms to acquire reputations for quality is a key ingredient for the efficient provision of complex commodities in a market economy. We build a model in which students with different innate abilities acquire skills as a function of the productivity of the schools they attend, and their own effort. If schools cannot select students based upon their innate ability, then a free market tends to raise school productivity. However, if schools use an entrance exam to select students, then competition leads to stratification by ability, reduced student effort, and in some cases lower school productivity.
Macleod, W.B.; Urquiola, M. Anti-Lemons: School Reputation, Relative Diversity and Educational Quality (IGC Working Paper). International Growth Centre (IGC), London, UK (2011) 37 pp.