Tuesday, August 02, 2011

DON'T PANIC

The last-minute debt deal not only displayed the impotence of the modern Democratic party, but also screwed over a lot of future grad students. There is an excellent post about it at ATL. Read it.

I don't have a lot to add, except I think it is time for Boalt's administration to reassess their reliance on the Federal IBR/forgiveness program as the central pillar of LRAP. We have repeatedly been reassured that IBR is safe. Now it looks like anything is on the table.

Enjoy your tea.

19 Comments:

Anonymous Anonymous said...

The benefit of loan subsidies eventually gets transferred to the institution anyways, and not to students.

Take the following example: Say you were willing to be $10,000 in debt for some course. Now the government says it will subsidize the loan by $1,000--so you would be in only $9,000 of debt.

But the fact is, you were willing to be in $10,000 of debt in the first place. So if the institution raises the cost of the course by the exact amount of the subsidy, you will make the same decision and end up in $10,000 of debt.

Where does the subsidy end up? With the institution, that's where.

Of course, markets are not really completely efficient. So it might take some time for the price of the course to factor in the subsidy. But the long-term effect is pretty much what I described above.

8/02/2011 4:31 PM  
Blogger Dan said...

Perhaps, but my real fear here is what happens when they need to come up with another $1.3 Trillion in cuts by Thanksgiving. The subsidies may just be first on a very long chopping block.

8/02/2011 4:59 PM  
Anonymous Tyler said...

4:31, your analysis is accurate (assuming the student willing to pay $10,000 is the "marginal student"), but did you forget the supply side of the market?

Under your free market assumptions, the law school was just covering the marginal cost of offering the course to your marginal student when it was pricing at $10,000. After the subsidy, it can cover its costs when students pay only $9,000 (because it's getting $1,000 from the government). So it is willing to offer the course to students that wouldn't have taken it at a $10,000 price, but are willing to do so at the $9,000 price. Sure, the number of slots in the class might be fixed in the short term, but in the long term it can build more classrooms (if the revenue from the new students is greater from the revenue lost from students willing to pay $10k), or new competitors will be attracted to the market by windfall profits.

Of course, that doesn't mean that students reap the whole benefit of the subsidy, either—you have to balance the demand effect you mentioned with the supply effect I mentioned. The standard way to model this is to draw a supply curve (upward sloping) and a demand curve (downward sloping). The intersection is the pre-subsidy equilibrium. The $1,000 subsidy shifts the demand curve up and to the right by $1,000. The new equilibrium is the new intersection with the supply curve. The quantity and price are both higher, but the price is not higher by the full $1,000. The benefits are shared between students and university. The share that each side gets depends on the slope of the supply curve. Only when the supply curve is vertical (perfectly inelastic supply), the whole $1,000 goes to the university, like you said.

I doubt that this simplified model sheds much light on the vastly more complex reality of the market for legal education. But it’s a fun game to play.

8/02/2011 5:45 PM  
Anonymous Anonymous said...

Tyler,

4:31 here. Your comment, as always, is spot on. I had not fully considered the effect on supply.

I'm not an econ major, but I think I understand what you are saying. However, I'm not sure if it is completely true here.

Law schools--at least Tier 1 schools--can already admit additional students at their current price point. They have significantly more applicants than available spots. Therefore, the fact that they can now service a student at $9000 does not matter when there are plenty of students waiting to pay $10,000.

I'm having trouble remembering the basics of econ, but isn't this an example of inelastic supply?

Of course, your point does strike me as true to some extent. New schools that would not enter the market at the $9000 price point are now likely to enter the market at the $9000 + $1000 subsidy price point. This results in an increase in supply that is attributable to the subsidy and that benefits the marginal student.

8/02/2011 11:58 PM  
Anonymous Anonymous said...

That'd be inelastic demand; i.e. consumers are willing to pay whatever price for a good because it is needed. This is especially exacerbated with students, where the "willing to pay" is actually willing to pay future fantasy dollars, since they get unlimited loans now.

8/03/2011 8:22 AM  
Anonymous Anonymous said...

Oh shit, I meant perfectly elastic demand, not inelastic. My bad! Undergrad was so long ago...

8/03/2011 8:23 AM  
Anonymous Anonymous said...

There is also inelastic supply, because increasing the price of education does not increase the supply; there is a fixed number of top-tier schools.

Beyond the top-tier schools, supply is not as inelastic. But then you have to ask yourself whether the subsidy is the best way to give money to schools. It really isn't: For one, it makes generally uninformed consumers (students at all levels) bear the risk of changes in the subsidy, rather than relatively few well-informed and well-represented suppliers (universities and colleges). Second, it is not tuned to support those schools worthy of (or requiring) such support. There are probably other reasons to think loan subsidies are inferior to other alternatives for grants, but this is before I've had coffee.

8/03/2011 8:44 AM  
Anonymous Tyler said...

Wow, I kind of wish Nuts and Boalts was always about Econ 101.

I agree with 4:31 and the other posters that the simplified perfect competition model doesn't reflect what really happens. But I also realized that I didn't even describe the perfect competition model right the first time. I think the graph was right, but I should have said something more like this:

Assume the market is at equilibrium at the $10k price. Then assume the $1k loan subsidy passes.

As 4:31 suggested, students are now willing to pay $11k for the same education, and each law school also would like to jack up their prices to $11k to capture the subsidy. But it can't. In a classic market based on price competition, their competitors will undercut them by charging (e.g.) $10,500 instead of $11,000, and thereby poach their market share. Eventually price is driven down to where the universities can just barely cover their costs of production, which under our assumptions is $10k.

However, now consider the demand side of the market. There are a bunch of students who weren't willing to go to law school for $10k, but are willing to go when the (effective) price is $9k. Accordingly, there are more people demanding legal education than before the subsidy.

Law schools (new or existing) want to make money off those students too, so they expand the number of spaces available. But the marginal cost of serving a student increases with each student you add. (This is the hardest part for me to understand, but it makes sense if you think about things like having to pay more to hire new professors who would really rather be in private practice or build new law schools on more expensive real estate.). Therefore, at the new higher quantity the price competition described above ends up driving the price down only to (e.g.) $10,500 instead of $10,000. This in turn moderates the increase in demand described above, until, in some very mathematically complex, permutative way, the market settles down to a new equilibrium at a slightly higher price and slightly higher quantity of education produced.

8/03/2011 12:24 PM  
Anonymous Tyler said...

Of course, as I said I totally agree with you that it's plausible that supply is inelastic (vertical). This might be especially true in the top school segment, because prestige works by limiting the number of people admitted. For example, maybe new law schools would like to enter the top tier market to capture the windfall caused by the subsidy. But even if they undercut existing top law schools prices, the new law schools can't position themselves in the "top tier" market, because the students with the LSAT scores that get you ranked as a top school are already taken.

In other words, this just isn't the price competition game modeled by the supply and demand curves I described.

And I also agree that inelastic demand (students willing to pay nearly anything for that prestigious education) is plausible too, at least up to a certain point (would you go to law school if it cost $300,000 a year?)

So in the end I find it plausible that the law schools really do reap all or most of the benefit of a student loan subsidy.

8/03/2011 12:27 PM  
Anonymous Anonymous said...

Can someone put all this discussion in terms a non-economist can understand?

8/03/2011 2:09 PM  
Anonymous Anonymous said...

More people buy cheap stuff, people have an incentive to sell expensive stuff, so changing the value of products via the government creates inefficient markets.

8/03/2011 3:15 PM  
Anonymous Anonymous said...

Why was my comment about elasticity, supply, and demand deleted? What's the deal?

8/03/2011 3:26 PM  
Blogger Armen said...

Sounds like blogger acting up. Happens when the comment is long. E-mail me or Patrick if you want the comment forwarded to you.

8/03/2011 3:30 PM  
Blogger Patrick said...

This is on behalf of 3:26:

Here's the unabridged version. When the government decides to subsidize the consumption of certain goods, two things can and often do happen. First, consumers may benefit from the subsidy. For example, imagine that it costs $5000 per semester to attend a certain school (including the present value of future interest payments). The government subsidizes the cost and says that it will give you $500 (PV) to attend school. Now it only costs you $4500 to attend. This means that, lucky you, you get to attend school for $500 less than you could have! It also means that your friend, who could only (or was only willing to) spend $4500 for school, can now attend, too.

Second, suppliers may benefit from the subsidy. Take the same example above, except let's imagine that there are a fixed number of schools, and there are a lot of people willing to pay $5000 per semester. Schools can actually raise the price per semester to $5500, because the consumers will pay $5000 and the extra $500 is being paid for by the federal government. (Interest on loans is simplified in this example.)

In the real world, both things generally happen, but in moderation. Who benefits from the subsidy depends on whose behavior is more sensitive to price changes, which economists term "elasticity." If a supplier's behavior is very sensitive to price increases or decreases (e.g., a supplier will produce more, or there will be more suppliers, if the price increases; vice versa with decreases), then we say that supply is elastic. A good example of inelastic supply is tuition at a T14 law school, because a change in price will not increase the number of seats they open to incoming 1Ls, and the number of T14 schools is fixed at fourteen.

If a consumer's behavior is very sensitive to price increases or decreases, we say that demand is elastic. A good example of inelastic demand is consumer demand for gasoline, because people need it even if price goes up, and people don't usually buy more when price goes down.

In my post-bar boredom I may make a figure showing how the elasticity of supply or demand determines who benefits from the loan subsidy when it comes to T14 law schools. But in lieu of that, the best graph is here:

http://en.wikipedia.org/wiki/File:Tax_incidence_%28producer%29.svg

When reading that graph, replace
(1) "with tax" with "without subsidy," and
(2) "without tax" with "with subsidy."

Then you will see that the incidence of the subsidy mostly falls on the supplier when demand is relatively elastic and supply is relatively inelastic. There is some debate about the relative elasticities but I think this is one fair view of the T14 education market today.

8/03/2011 3:32 PM  
Anonymous Anonymous said...

Hey, thanks a bunch.

8/03/2011 3:36 PM  
Anonymous Tyler said...

I agree with everything 3:26 said. That is what I would have said if I knew how to say it as clearly as 3:26.

Except that the graph 3:26 linked to models a tax/subsidy which falls initially on producers (in this case, the university). Loan subsidies fall initially on consumers (the students). That's why I think its actually a demand curve shift, more like this: http://en.wikipedia.org/wiki/File:Supply-and-demand.svg.

8/03/2011 4:12 PM  
Anonymous Anonymous said...

Sigrid recommended this website, www.askheatherjarvis.com, for updates on IBR and PSLF. The "Student Loan Expert" recently answered some similar concerns about how secure the PSLF program is:
http://askheatherjarvis.com/forums/viewthread/8/

8/04/2011 10:13 AM  
Anonymous Anonymous said...

That thread is close to worthless. Basically it just says that, yes, Congress would need to act to do away with PSLF. Who didn't know that? Congress can act by, for example, passing a bill to increase the debt ceiling that contains a clause eliminating educational loan subsidies. Poof! Congress acted, and it's gone.

It's all a guessing game, but it's a guessing game on which you bet tens of thousands of dollars. The mere fact that "it would take an act of Congress" to destroy PSLF is in no way reassuring.

8/04/2011 12:18 PM  
Anonymous Robert said...

Such a great article it was which The last-minute debt deal not only displayed the impotence of the modern Democratic party, but also screwed over a lot of future grad students. In which repeatedly been reassured that IBR is safe. Thanks for sharing this article.

2/12/2012 3:07 AM  

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