Question

Jimmy, an economist, argues that governments should tax the general population in order to subsidize the post-secondary education of those attending universities and colleges. He says that “…everyone in society benefits from having an educated workforce.” Jimmy also argues that there is a healthy private return to investing in a post-secondary education.

Using a well-labelled diagram, explain how subsidizing post-secondary education will improve economic efficiency/social welfare.

Clearly identify the type of market failure, why it exists, and explain how the subsidy will correct for this failure.

Answer 1

"...everyone in society benefits from having an educated workforce." Jimmy's words indicate that education has a positive externality that benefits others beside the educated person. This equation can be represented in the following graph:

  

In the graph above, PMB (personal marginal benefit) is the demand curve of the individual for education. It is below the socially desirable level represented by SMB curve(social marginal benefit). But higher level of education is also more expensive. The individual may be unwilling to incur higher expenditure to obtain higher education. However, education, emitting positive externality, is beneficial to the society. So increase in higher education creates external marginal benefit, EMB, which is beyond the individual's PMB.

The green triangle contains two smaller, horizontal triangles. If the government provides subsidy, it would encourage more individuals to opt for higher education and would reduce the gap (or close the gap) between P1 and P2, covering the lower triangle. The gap of the upper triangle would remain as all individuals would not be able to achieve fullest level of education. But government subsidy would reduce the deadweight loss (the whole of the green triangle) till P2 line. In other words, it would enable individuals to get higher education at the same cost, P1.