Question

In the country of Utopia, individuals live two periods (period 0 and period 1) and must decide between two alternative income paths.

- “No College”: work full time in both periods, and receive an income of 200 in both periods (Y0,nc = Y1,nc = 200). One can save any amount at interest rate r = 0, but cannot borrow at all (i.e., the interest rate for borrowing is effectively infinite).

- “College”: In period 0, go to college, work part-time and earn 120 (Y0,c = 120). In period 1, work full time and earn 300 (Y1,c = 300). One can save any amount at interest rate r = 0. One can also take on a student loan of up to 40: that is, it’s possible to borrow up to 40 at an interest rate 0 (but it’s not possible to borrow more than 40 – the interest rate for any borrowing beyond 40 is effectively infinite).

Assume that attending college does not yield any direct utility and that the amount of leisure is identical under both income paths. Assume also initially that tuition is zero. Under the current circumstances, some individuals in Utopia choose to attend college, and others choose not to attend college.

a) Draw the budget constraints under the two alternative paths. Make sure to label your graph carefully.

b) Assume that the period 1 income if one attends college (Y1,c) increases, while all the other parameters remain constant. What will happen to the fraction of people who attend college? What will happen to the amount of borrowing in the economy? Use a graph to explain your answer.

c) Assume that tuition increases, meaning that the net period 0 income (Y0,c) if one attends college decreases. What will happen to the fraction of people who attend college? What will happen to the amount of borrowing in the economy? Use a graph to explain your answer.

d) In recent years, there has been an explosion in the amount of student loans, and also an increase in college enrollment. In light of your answers to parts b) and c), what factor can explain both trends: an increase in the economic returns to college, or an increase in tuition?

Answer 1

Assume that the financing cost on investment funds is r, the lifetime spending imperative can be given as:

C1 + C2/(1 + r) = Y1 + Y2/(1 + r)

There is no financing cost for limiting. Subsequently, the two spending conditions are

C1 + C2 = 200 + 200 or C1 + C2 = 400..................... at the point when one doesn't attend a university

C1 + C2 = 120 + 300 or C1 + C2 = 420..................... at the point when one selects to go to school

a) The two-lifetime spending imperatives are drawn beneath

b) Here we see that the salary from setting off for college rises with the goal that the financial limit constraint for understudies becomes C1 + C2 = 440 (state an ascent of $20 in 120 to become $140)

This moves the spending line up. With no limiting, this will urge more individuals to set off for college consequently the division of individuals attending school rises. Acquiring should be possible till $40 so obtaining will increment if at first, the understudies were borrowers

c) Here we see that the salary from heading off to college falls with the goal that the financial limit constraint for undergrads becomes C1 + C2 = 410 (state a fall of $10 in 120 to become $110)

This moves the spending line down. It might move it down to match with the spending line with no school. Nonetheless, we don't expect this. With no limiting, this will demoralize more individuals to set off for college subsequently the division of individuals attending school falls. Getting should be possible till $40 so obtaining will diminish if at first, the understudies were borrowers as they presently choose not to go to the school

d) Definitely, an expansion in educational cost can't expand enlistment. Its the better yield that has pulled in numerous understudies to join school when they pass High school