Marginal Utility and College Costs (Wonkish Theory)

As President Obama makes his case for a higher education system that can be quantified in quality, it strikes me that most colleges do not operate on market principles on a micro level. Most markedly, they do not use Marginal Utility as a driving force of services.

Most students don’t care about their bill. They not only have parents, or financial aid paying for their education, but they take out loans under the misguided view that it’s “aid”; something that they don’t have to worry about paying back until later. In other words, the long run doesn’t override short run decisions (kind of hedonistic). Here are the consequences of that to the economy in the form of government owned debt, which is largely student loans:

fredgraph

Student loans are basically putting education on a credit card. What do people get for their money? In other words, where’s the marginal value? Let me set an Economic and Social backdrop.

Utility is simply the usefulness of something, Marginal Utility is the price I’m willing to pay for that usefulness. Marginal Cost is the cost to provide that useful good or service to me. For example, If I need a hammer to pound some nails in my house, then a hammer has “utility”. If the nails I need to pound are keeping my house from falling down, then I’m willing to pay more for that hammer. That hammer is going to be REALLY useful to me (Marginal Value)! If the nails I need to pound aren’t any big deal, then I may be willing to wait and look for the best bargain on hammers. This is known as Marginal Utility. If a company can produce a hammer for the price that I’m willing to pay for it, then this is known as Marginal Cost. Marginal Cost should never exceed Marginal Utility (the price I’m willing to pay), or else someone loses money.

Now if the company makes more hammers than people like me need (or want), then that is called the law of diminishing marginal utility. I only need one hammer. If a company makes two hammers, then the second hammer is of no use (utility) to me. The company is forced to keep its hammer (inventory) until is looks for someone else to buy it (marketing). This is exactly what happened to Microsoft last quarter when it made $1 Billion worth of tablets that no one wanted.

Now if I end up paying $50 for a super-duper hammer and all I’m doing is hanging a picture frame, then I lose marginal value when I could’ve done the same thing with a $5 hammer. The company makes its marginal cost, because I was willing to pay for the marginal utility. But I’ve lost money through marginal value ($45).

How do we fit this into education? If I’m in college, what am I paying for? Education. There’s more to education than just sitting in the classroom. There is education through community service, internship experiences, and organizations that promote multicultural activities as well. This is what I call “Educational Utility” – it has usefulness in the overarching goal of “Education”. Now what am I willing to pay for it? What’s its “Marginal Utility?” Well, that’s up for debate; I can either pay great big whacking gobs of money, or I can just pay a lot of money. Unlike the hammer, where I can pay $5 or $50, with any variable in between, there really isn’t a choice in Education. And that’s because in the general world, there’s debate over the Utility (usefulness) of education in achieving its goal; improving socioeconomics. In other words, the hammer may not work in pounding the nail.

What is the Utility of Education versus Marginal Cost? That’s what the President is trying to answer. The number of unemployed people with a Bachelor’s degree is the highest it’s ever been in the history of the record. That’s not to say that professors shouldn’t get paid, but that does bring up the question of what services does a college provide (other than professors and classrooms) that makes the Marginal Costs greater than the Marginal Utility? Is there value added? And why doesn’t market forces seem to apply since the consequences are – market forces (especially in labor markets)?

Politics is supposed to be about public policy. Hopefully policy can make sense of it.

 

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