Question

Consider the perfectly competitive market for tertiary education. Research has found that countries with higher level of tertiary educated population have lower levels of crime.

1. Draw the market demand and supply for tertiary education, labeling both the market outcome and the socially optimal outcome. Explain your graph.

2. Is the market outcome and the socially optimal outcome the same? Explain your answer.

3. If your answer in part (b) is no, explain two possible solutions for achieving the socially efficient outcome. However, if your answer in part (b) is yes, explain two possible factors that could cause the market outcome to be different from the socially efficient one.

Answer 1

a. The diagram shows that the supply curve (or marginal cost curve) of education is upward sloping. The private marginal benefit curve represents the demand curve that is perceived by the private players.

However, education also has a positive externality for the socoety. It reduces crime. Thus, we will also have to consider a social marginal benefit curve. By adding the private benefit and social benefit from education, we get total marginal benefit curve.

The private optimum quantity is reached when the supply curve intersects the private marginal benefir curve. The private optimum quantity is given by Q. On the other hand, the social optimum is reached where the total marginal benefit curve intersects the supply curve. The socially optimum quantity is Q1.

b. The social optimum quantity is different from the private optimum quantity or market outcome.

The reason is that the market curves do not internalize the benefits received from the positive externality of education. When these benefits are internalized, the social optimum quantity comes out to be greater than private quantity.

c. The private optimum quantity can be made equal to the social optimum quantity through two solutions given as:

i. Pigouvian Subsidy: Pigou says that in case of positive externality, the state can subsidise the product or service in such a way that the private marginal benefit becomes equal to the social marginal benefit. This will equate the private and social optimum quantity. The amount of subsidy in this case is marked in the diagram.

ii. The other solution is that government can provide the tertiary education to individuals through public institutions. In this case, both the private and public institutions can co exist.