Question

Suppose some students are able to borrow for college at a rate of 5%, which also is the market rate of return. For other students, the only source of funds to borrow for college is Louie the Loanshark, who charges an interest rate of 20%. What are the consequences for the educational attainment of these different students? Is there a potential role for government intervention in the education market?

Explain the difference between a short-run and a long-run credit constraint. Give an example of a policy that could overcome each type of constraint. Why is it important for financial aid policy to distinguish between short- and long-run credit constraints?

Answer 1

Education has important functions in contemporary American society. In economics, it is considered an investment in human capital which enhances the recipient's future productivity. The U.s. is a nation comprised of ethnically diverse peoples. But unfortunately, the level of educational attainment varies significantly across some of these groups.

Loans are observed to have a negative effect on persistence and no effect on degree attainment. The findings are attributed to a combination of the high uncertainty of degree completion among college students and the negative effect component of indebtedness.

The consequences for the educational attainment of the students having a loan with different interest rates are that students who have low-interest rate such as Government loans are such that their terms and conditions of repayments are set by law and include many benefits which are not offered to students having private loans with high-interest rates. Private loans are made by private organizations and have terms and conditions that are set by the lender. Private student loans are more expensive and it will be a burden to students to repay it as the interest amount will grow enormously into a big amount. Students who are the first in their families to attend colleges, already face a disproportionate burden from loan debt and that is likely to increase with higher interest rates. This is unfortunate for all students but it will be the greatest effect of the interest rate increase will be on students who already face the greatest hurdles in financing their education.

The Government tries to combat market inequities through regulation, taxation and subsidies. An example of his includes breaking up monopolies and regulating negative externalities in the educational system.. Government may sometimes intervene in educational markets to promote other goals.

Government intervention to provide free education can lead to a significant improvement in the quality of life for people who are educated. There are also many positive externalities for the rest of society. A well-educated society can improve labour productivity and economic growth. The overall message here is that the federal government has the responsibility of ensuring the right to free and high-quality education for all students by protecting their civil rights and by providing resources for the most in need, using public data and high-quality research and by providing support and adopting a suitable policy.

We distinguish short-run liquidity constraints from the long term factors that promote cognitive and noncognitive ability. Long-run factors crystallized inability are the major determinants of the family income - schooling relationship, although there is some evidence that 8% of the total US population is credit constrained in the short run. The observed correlation between family income and educational outcomes can be interpreted as arising from two quite distinct sources (1) short tun credit constraints, whereby limited access to credit markets means that the cost of funds is higher for children of low-income families.

To escape the credit constraints, there are many financial policies adopted by governments/ individuals. All assets of a debtor serve as collateral for all their debts.