question:
Is the following true or false?Explain your reasoning.
If the quantity of higher education services supplied does not increase with the price of that service, that is, if supply is perfectly inelastic, then subsidies for the demand for higher education services primarily benefit universities and their employees.
Solved:
I use this question in my Microeconomic Principles class to get students thinking about the current beneficiaries of real-world policies that many believe are aimed at their benefit. However, whether subsidies benefit students depends on how quickly the supply of higher education services can respond. In other words, the important question is not the purpose of the subsidy, but what happens in the market when additional purchasing power is introduced.
This question asks us to assume that the supply of higher education services is completely inelastic, meaning that no matter how high or low tuition costs, the number of seats and credit hours offered by universities remains fixed. With subsidies, students are willing to pay more, but because they cannot increase the amount of instruction, competition among students for a certain number of spots pushes up tuition costs instead of increasing enrollment. In this case, the price of higher education services increases by the amount of the subsidy.
Since the quantity is fixed and the price increases by the amount of the subsidy, universities can maximize the benefits of the subsidy. Additional revenue accrues to the university rather than to students and may appear as increased salaries and benefits for existing faculty, increased administrative spending, or other forms of institutional surplus. In contrast, students do not benefit from subsidies at all because the price of higher education services increases without increasing the amount of education provided.
Therefore, this statement is true.
Of course, in reality, the supply of higher education services is not completely inelastic, especially in the long run. Universities can ultimately expand enrollment by adding facilities or hiring additional faculty, but how quickly they can do so depends on how easily they can expand critical inputs. Some universities are able to adjust relatively quickly, while others are not. As a result, supply may be much less responsive in the short term than in the long term.
Some of the comments on the posted question raise these real-world considerations, but move away from the assumptions built into the question. This question specifically asks us to assume that supply is perfectly inelastic. Once this assumption is taken seriously, the results are no longer ambiguous. If quantity is fixed, a subsidy that increases students’ willingness or ability to pay will appear as a higher price rather than an increase in quantity. Therefore, comments calling for increased production capacity, changes in quality, and adjustments in wages are answering another question to which the supply side can respond.
Similarly, questions about how additional revenue is distributed within the university do not affect our central results. Even if internal wages and employment do not change at all, the subsidies are still being funneled to universities, not to students, in the form of higher tuition revenue. And it is important to distinguish between demand-side subsidies and policies that directly keep tuition costs below market levels. Only the former is relevant here. If the number of seats is fixed, increasing student purchasing power only increases tuition costs.
