by Kay McLennan

July 30, 2001

Required Textbook: 

Background: Why study the economics of education?

The study of the economics of education not only provides insights into matters of interest to those who work and live in college and university communities, but also is important to every member of society. Examples of the ways higher education both impacts and is impacted by the economy include the following.

		For faculty and administrators alike, economics (or the interaction of supply and demand in the labor market for faculty and administrators) provides the explanatory framework for salary levels
		For administrators, the finding that enrollment levels and endowment earnings are tied to the relative health of the economy is of keen interest. (Historically, during economic downturns, enrollments decline and during economic expansions, enrollments increase.)
		For individuals, higher education has the potential to dramatically enhance work life earnings—college graduates can now expect to earn more than double the work life earnings of a high school graduate.
		For all of society, the fact that education and advances in knowledge have historically contributed more to the growth in real GNP than either capital or labor inputs alone is a dramatic finding (Samulelson & Nordhaus, 1997). Still, it is even more interesting to note how the much-touted "New Economy" is based on the production and utilization of knowledge alone (versus the production of physical goods with the land, labor and capital factors of production)!

In addition, higher education-led fields like industrial ecology may hold our best hope for solving one of the world’s most pressing problems, namely how to live within our various global eco-spheres.

Higher Education Economics Tool Kit

Higher Education and the Individual

Tradeoffs – Individuals make decisions about attending college by comparing what they have to give up versus what they will gain. The decision to devote time and financial resources to a college education means an individual will not have these resources to use in other ways. Still, Baum (1995) notes how researchers continue to question whether "young people …[who] have no experience with higher education may underestimate its value."

Costs – Not only does the cost of a college education include the amounts paid for tuition, fees, books and living expenses, but the value of things given up like foregone earnings. Opportunity cost is the term applied to what is given up by individuals when they choose among various alternatives.

Making Decisions at the Margin – Even the decision to attend college entails numerous decisions at the margin. (In economics parlance, marginal changes are understood to be small incremental changes.) For example, students can select whether to attend a public or private institution, pursue their studies on a full- or part-time basis, etc.

Incentives – All individuals are motivated by incentives. More specifically, people act rationally as they attempt to avoid costs (or unpleasant consequences) and garner benefits (maximize their enjoyment or utility). In turn, college scholarships and subsidized educational loans result in increased enrollments in higher educational institutions. However, when tuition charges increase, some students will elect to not attend college. Yet, any increase in tuition has to be considered in the context of both costs and benefits. That is, the benefit side of the higher education equation continues to provide a big and growing incentive--in our present day economy, college graduates can now expect a sizable pay-off in terms of increased lifetime earnings.

Additional/Optional Reading:

For additional readings on the basic economics principles summarized above, look in the library for: 1) a basic economics textbook in the library like the Principles of Economics by N. G. Mankiw (Fort Worth: The Dryden Press, 1998); and 2) a basic labor economics textbook like The Economics of Labor Markets. (Chapters 1 - 6) by B. E. Kaufman & J. L. Hotchkiss (Fort Worth: Dryden Press, 2000).

Higher Education and the Economy

Institutional Vulnerability to Economic Downturns – Colleges and universities typically receive less state and federal funds in periods of economic downturns and recessions. [In 1984-1985, private institutions received 18.4 percent of their income from public funds in comparison to public institutions that received 59.3 percent of their income from public funds (Slaughter & Leslie, 1997).]

In addition, the poor stock market and other portfolio instrument performance attendant to economic downturns lead to reduced returns on college endowments. [According to Slaughter & Leslie (1997), private institutions received 42.9 percent of their income from "other" sources like endowment returns in 1984-1985 while public institutions received 23.7 percent of their income from "other" during the same period.]

Finally, higher priced institutions can expect decreased enrollments as students have added incentives to seek out the lowest priced postsecondary educational opportunities. However, some the largest and wealthiest private institutions realized such dramatic growth in their endowments during the 1990s that they have a substantial cushion for future economic downturns.

Economic Growth (or increased GNP or Standard of Living) – Economic growth refers to an increase in a country’s gross national product (GNP). Taking the United States as an example, for individual consumers, the steady increase in economic growth that has occurred in the economy has led to a progressively higher standard of living.

Looking specifically at the different elements that contribute to growth in real GNP, the contribution of the factors of production include land, labor and capital inputs. In addition, growth in real GNP occurs as the result of productivity increases originating from education and other advances in knowledge. From the standpoint of magnitude, historically in the United States (starting with the period following the end of WWII), slightly more than half of the growth in real GNP has come from growth in labor and capital. The balance (slightly less than half) of the growth in GNP is attributed to education, industrial and scientific advances and other related factors.

Rationale for Public Support of Postsecondary Education

Market failures (defined to be an inefficient allocation of resources) occur because of the presence of externalities and concentrations of market power. While externalities are typically negative, it is possible for economic endeavors to generate positive externalities). Negative externalities occur when one individual’s (or firm’s) actions impinge on the well being of others (the often cited example of a negative externality is pollution from a particular manufacturing concern degrading the air and/or water in the surrounding community). Positive externalities occur when members of society benefit from others engagement or consumption of certain commodities. Education is thought to generate positive externalities where the individuals that receive more education increase the productivity of the aggregate economy.

The three rationales advanced for government support of higher education include how: 1) government support of higher education is necessary to realize all socially justified investment in college education; 2) government support of college education is necessary to achieve the socially optimal amount of student borrowing; and 3) government support of college education is thought to be a means for increasing college enrollment by students from lower income households.

However, it is important to note that the presence of efficient markets (where the optimal allocation of resources needed to produce the most output is achieved) does not often entail the most equitable distribution of output or wealth.

Suggested Reading:

College education: Is it worth the cost? (2001). In M. R. Edgmand, R. L. Moomaw, & K. W. Olson, Economics and contempoary issues (pp. 241-245). Fort Worth: Harcourt College Publishers.

The Decision to Invest in a College Education

Cost-Benefit Analysis

Suggested Readings:

College education: Is it worth the cost? (2001). In M. R. Edgmand, R. L. Moomaw, & K. W. Olson, Economics and contempoary issues (pp. 229-240). Fort Worth: Harcourt College Publishers.

Haveman, R. & Wolfe, B. (1984). Schooling and economic well-being: The role of nonmarket effects." Journal of Human Resources, 19 (3), 153-174.

Heckman, J. J. (1999). Doing it right: job training and education. The Public Interest (135), 86-107.

Kane, T. and Rouse, C. (1995). Labor market returns to two- and four-year colleges: Is a credit a credit and do degrees matter? American Economic Review, 85 (3), 600-614.

Tsang, M. C. and Levin, H. M. (1985). The economics of overeducation. Economics of Education Review, 4(2), 93-104.

The Human Capital and Screening Models

Suggested Readings:

Kaufman, B. E. & Hotchkiss, J. L. (2000). The economics of labor markets, Chapter 7, Education, training, and earnings differentials: The theory of human capital and Chapter 8, Occupational wage differentials. Fort Worth: Dryden Press.

Weiss, A. (1995). Human capital vs. signaling theories of wages. Journal of Economic Perspectives, 9, 133-154.

IV. Public Provision and Public Support of Higher Education

Suggested Readings:

Baum, S. (1995). The federal role in financing higher education: An economic perspective [On-line]. Available at: http://www.ed.gov/offices/OPE/PPI/FinPostSecEd/title.html.

Fisher, F. (1990). State financing of higher education: A new look at an old problem. Change, January/February.

Gladieux, L. E. (1995). Federal student aid policy: A history and an assessment [On-line]. Available at: http://www.ed.gov/offices/OPE/PPI/FinPostSecEd/gladieux.html.

Hauptman, A. M. (1995). Cut the cloth to fit the student: Tailoring the federal role in postsecondary education and training [On-line]. Available at: http://www.ed.gov/offices/OPE/PPI/FinPostSecEd/hauptman.html.

Johnstone, D. B. (1995). Starting points: Fundamental assumptions underlying the principles and policies of federal financial aid to students [On-line]. Available at: http://www.ed.gov/offices/OPE/PPI/FinPostSecEd/johnston.html.

McPherson, M. S. & Schapiro, M. O. (1991). Does student aid affect college enrollment? New evidence on a persistent controversy. The American Economic Review, 81 (1), 309-318.

McPherson, M. S. (1993). How can we tell if federal student aid is working? In M. S. McPherson, M. O. Schapiro, & G. C. Winston (Eds.), Paying the piper, productivity, incentives, and financing in U.S. higher education (pp. 135-164). Ann Arbor: The University of Michigan Press.

Financial Aid – Efficiency and Equity Considerations

Suggested Readings:

Edlin, A. (1993). Is college financial aid equitable and efficient? Journal of Economic Perspectives, 7 (2), 143-158.

Hansen, W. L. (1970). Income distribution effects of higher education. Papers and Proceedings of the Eighty-second Annual Meeting of the American Economic Association. The Economic Review, 60 (2), 335-340.

Hanuskek, E. A. (1989). Expenditures, efficiency, and equity in education: The federal government’s role. Papers and Proceedings of the Hundred and First Annual Meeting of the American Economic Association. The American Economic Review, 79 (2), 46-51.

Hartman, R. W. (1972). Equity implications of state tuition policy and student loans. Part 2: Investment in education: The equity-efficiency quandary. The Journal of Political Economy, 80 (3), S142-S171.

The Cost Structure (and Rising Costs) of Higher Education

Suggested Readings:

Hauptman, A. M. & Merisotis, J. P. (1997). The college tuition spiral: An examination of why charges are increasing. In L. Goodchild, C. Lovell, E. Hines, & J. Gill (Eds.), Public policy and higher education. Needham Heights: Simon & Schuster Custom Publishing.

Leslie, L. L. & Brinkman, P. T. (1987). Student price response in higher education: The student demand studies. Journal of Higher Education, 58 (2), 181-204.

Leslie, L. L. & Rhoades, G. (1995). Rising administrative costs: Seeking explanations. Journal of Higher Education, 66 (2), 187-212.

Stringer, W. L., et al. (1999). Cost, price and public policy, peering into the higher education black box. Indianapolis: USA Group Foundation.

Senate Hearing, 106-515 (2000). Rising cost of college tuition and the effectiveness of government financial aid [On-line]. Available at: http://www.lib.ipfw.edu/pirs/fed/hot-topics_00.html (follow links for either text or PDF files).

The Institute for Higher Education Policy. (1999). The tuition puzzle, Putting the pieces together. Washington: The Institute for Higher Education Policy.

Educational Reform

Suggested Readings:

Edgmand, M. R., Moomaw, R. L. & Olson, Kent W. (2001). Economics and contemporary issues, Chapter 9, Educational reform: The role of incentives and choice. Fort Worth: Harcourt College Publishers.

General Accounting Office. (1992). Guaranteed student loans [On-line]. Available at: http://www.inform.umd.edu/EdRes/Topic/US+W/US/Agencies/Exec/GAO/HighriskSeries/Stuentloans.

Kolb, C. E. (1995). Accountability in postsecondary education [On-line]. Available at: http://www.ed.gov/officies/OPE/PPI/FinPostSecEd/kolb.html.

Mumper, M. & Ark, P. V. (1991). Evaluating the stafford student loan program: Current problems and prospects for reform. Journal of Higher Education, 62 (1), 62-78.

Nettles, M. T. (1995). Pursuing broader participation and greater benefit from federal college student financial aid [On-line]. Available at: http://www.ed.gov/offices/OPE/PPI/FinPostSecEd/nettles.html.

Higher Education and the New Economy

Suggested Readings:

Blumenstyk, G. (2001, February 9). Knowledge is ‘a form of venture capital’ for a top Columbia administrator. The Chronicle of Higher Education, p. A49. [Or on-line at: http://chronicle.com/weekly/v47/i22/22a02901.htm.]

Cote, L. S. & Cote, M. K. (1993). Economic development activity among land-grand institutions. Journal of Higher Education, 64 (1), 55-73.

Fairweather, J. S. (1989). Academic research and instruction: The industrial connection. Journal of Higher Education, 60 (4), 388-407.

Meyer, L. H. (2000, June 6). The new economy meets supply and demand, Remarks before the Boston Economics Club [On-line]. Available at: http://federalreserve.gov/boarddocs/speeches/2000/20000606.htm.

Schmidt, P. (2000, February 25). Public universities get money to attract high-tech industry. The Chronicle of Higher Education, p. A42. [Or on-line at: http://chronicle.com/weekly/v46/i25/25a04201.htm.]

Woodard, C. (2001, April 13). Growing greener industries, Scholars help companies take a lesson from nature to turn pollution into profit. The Chronicle of Higher Education, p. A22. [Or on-line at: http://chronicle.com/weekly/v47/i31/31a02201.htm.]