Policies – positive externalities of consumption

Q:  Governments typically intervene in the market for education in several ways.
Discuss whether such intervention will help a government meet its microeconomic objectives.  (15m)

 micro objectives – efficiency / equity

 To address efficiency (allocative efficiency)

1.      Market-oriented approach (eg. Subsidies) – incentives to affect behavior

2.      Regulation approach – law to affect the behavior (must do something / cannot do something)

3.      Education and advertising approach – influence the behavior (eg. pre-school)

 ANS:

In a market for education, positive externalities of consumption likely arise. This leads to under-consumption in the free market, giving rise to deadweight loss. To achieve the microeconomics objectives, namely efficiency and equity, in the market for education, the govt may intervene in several ways. The effectiveness of the policies in achieving these objectives will be discussed below.

The govt may adopt a market-oriented approach, such as by providing subsidies for education. In the case of SG, the govt has provided top-ups to the Post Secondary Education Account it set up for local students, to allow them to use the funds for their tertiary education. This would allow the tertiary education to be made cheaper to them, thereby encouraging more consumption. The diagram is shown below.

With the provision of the subsidies to consumers directly, the demand for education services increases. This is shown by a rightward shift of the MPB (demand) curve to the position of the MSB curve, allowing actual consumption to increase from Q0 to Qae. Allocative efficiency may thus may be achieved in the market when the deadweight loss is removed. Allocative efficiency refers to when the social welfare of the market is maximized.

Equity refers to being fair or just. The subsidies may be equitable, as it provides more funding for the lower-income households. This is as compared to the higher-income households, and will thus allow both groups of households to consume the same level of education services. (OR the subsidies may form a larger proportion of the income of the lower-income households. This implies that the subsidies will assist them in being able to consume education more than it does for the higher-income households, leading to higher levels of equity.)

Limitations in achieving allocative efficiency
However, as the MEB is often difficult to quantify, it becomes difficult for the govt to provide subsidies that will fully remove the deadweight loss in the market. From the diagram above, the MPB curve has to shift to

Trade-offs of the subsidies
In addition, the subsidies may also incur an opportunity cost. This refers to the value of the next best option given up. Since the subsidies are spent on education, it may not be spent on other areas, such as healthcare and defence. Whether it is then justified to provide such subsidies will depend on the relative benefits of achieving allocative efficiency and the costs of doing so, in terms of the opportunity costs.

Limitations in achieving equity
In terms of achieving higher levels of equity, the subsidies given may not be fully effective as well. For instance, in SG, the KiFas scheme provides additional subsidies to households who are less able to afford pre-school services. The monthly household income ceiling is capped at $12,000. This level of income ceiling was determined arbitrarily by the govt, and may not reflect the separation between higher and lower income groups in SG. Households with higher incomes than $12,000 may still face difficulties in consuming pre-school services, but they do not qualify for this scheme. Hence equity may not be maximized as not all needy households will get access to the subsidies.

 In addition to the subsidies, the govt may also implement laws and regulations to promote the consumption of education. In the case of SG, the govt passed the Compulsory Education Act in 2000 to make primary education compulsory. Children who turn 7 must be enrolled in a primary school, failing which the parents would be guilty of an offence. This policy will cause the demand for education services to increase, as shown by a rightward shift of the MPB curve. Allocative efficiency may be achieved when consumption increases to Qae.

 However, monitoring costs and enforcement costs may be very significant with the regulation approach. For the laws to be effective, the govt may need to spend resources, such as police, to check and ensure that all children are enrolled in primary schools. They must be able to find any one child who is not enrolled, and mete out the appropriate punishments or corrective actions. This may mean that the costs of implementing the laws can be significant, and may outweigh the benefits of achieving allocative efficiency.

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