The purpose of the present paper is to construct an explicitly dynamic model of non-human and human capital formation (i.e. , education) when there is wage rigidity in the market for educated manpower, and hence graduate unemployment. Within the framework of this model, I will then consider the question of second-best policy measures (such as employment subsidies or changes in the private costs of education), given that the wage rigidity cannot be directly removed. I will show that under certain conditions, the appropriate shadow price of labor may be equal to, or even exceed, its market wage even when graduate unemployment exists, and that the optimal level of employment subsidy may be positive or negative. I will also demonstrate that the problem of rigid wages may lead to a situation analogous to the one consider-by Bhagwati and others in the work on “immiserizing growth”, in which attempts to raiseth long-run level of consumption in the economy through additional capital formation, will in fact reduce long-run welfare.