Question

Over the last 30 years in the United States, the real price (adjusting for inflation) of a college education has increased by almost 80 percent. Over the same period, nationwide college enrollments have almost doubled. While faculty salaries have barely kept pace with inflation, administrative staffing, expenditures, and capital costs have increased significantly. In addition, government support to universities (particularly research funding) has been cut. In your response, provide a thorough explanation to each discussion question and prompt.

1. College enrollments increased at the same time that average tuition rose dramatically. Does this contradict the law of downward-sloping demand?

2. Use supply and demand curves (or shifts therein) to explain the dramatic rise in the price of a college education.

3. What market does the college education industry operate within? Why?

Answer 1

Answer 1

The law of the downward sloping demand curve states that there is an inverse relationship between the price and the quantity demanded of a good or a service i.e. as the price of a good or service increses, it's quantity demanded decreases and vice versa, keeping other factors constant. Therefore, the demand curve is a downward sloping curve due to the negative relationship between price and quantity.

As per the given information, we see that college enrollment has increased at the same time that average college tuition rose dramatically. But this does not contradict the law of downward sloping demand curve. This is so because although the average tuition fees has increased but the demand curve for college education had shifted rightward due to other factors which are taken as constant in the law of demand and it is because of this rightward shift in demand curve that college enrollment has increased despite rise in college tuition. The rightward shift of the demand curve means that the demand for college education has increased at all price levels. This rightward shift of demand has occurred due to changes in other factors. Due to technological upgradation during the last 30 years in US, there has been a higher demand of highly qualified and skilled professionals and they are paid better wages than others who have not attended college. The prospect of such higher wages has led people to enroll for more college education despite the rising college tuition. The following diagram will make this concept clearer.

Demand curve has shifted rightward at all price levels.

Answer 2

Since the demand for college education has increased at all price levels, so the demand curve has shifted rightward as there are prospects of higher pay associated with higher education.

At the same time, the costs of providing college education have increased due to inflation, higher administrative costs, higher capital costs, staffing expenditures and so on. While the government support to universities has gone down. Due to these increase in the costs of providing education, supply has gone down at all price levels as college education providers are willing to supply only at higher prices. Due to this, supply curve has shifted leftward.

The rightward shifted demand curve and leftward shifted supply curve will not intersect at a higher price, therefore the college tuition has increased.

Increase in demand and decrease in supply, both lead to an increase in the price of the good or the service.

The following diagram will explain this better.

On x - axis, we have college enrollment, on y-axis, college tuition. D1 is the original demand curve, S1 is the original supply curve. E1 is the original equilibrium with P1 as equilibrium college tuition and Q1 as original college enrollment.

The demand curve shifts rightward due to external factors from D1 to D2. Supply curve shifts leftward due to increase in costs of providing the service from S1 to S2. New supply and demand curves intersect at E2 with higher prices P2 and higher college enrollment Q2.

Answer 3

The college education industry operates within perfect competition market structure. It is perfect competition because a large number of buyers and sellers exist in the market and they are price takers and not price makers. Prices are determined by the market forces of demand and supply and neither individual buyer nor individual seller is large enough to influence market price. Hence, they have to take whatever price is being determined by the market.

There is freedom of entry and exit in the market. There are no abnormal profits or losses due to freedom of entry and exit. Also, all colleges are providing similar education so homogenous product which is a feature of perfect competition market structure.