Externalities
Education is an example of a positive externality: acquiring more education benefits the individual student and having a more highly educated work force is good for the economy as a whole.
The accompanying table illustrates the marginal benefit to Sian per year of education and the marginal cost per year of education. Each year of education has a marginal external benefit to society equal to $8,000. Assume that the marginal social cost is the same as the marginal cost paid by an individual student.
|
Quantity of Education (in years) |
Sian’s Marginal Benefit per year |
Sian’s Marginal Cost per year |
|
9 |
– |
– |
|
10 |
$20,000 |
$15,000 |
|
11 |
19,000 |
16,000 |
|
12 |
18,000 |
17,000 |
|
13 |
17,000 |
18,000 |
|
14 |
16,000 |
19,000 |
|
15 |
15,000 |
20,000 |
|
16 |
14,000 |
21,000 |
|
17 |
13,000 |
22,000 |
- Find Sian’s market equilibrium number of years of education
- Calculate the marginal social benefit schedule
|
Years of Education |
Sian’s marginal benefit per year |
Marginal external benefit to society |
Marginal social benefit |
Sian’s marginal cost per year |
|
9 |
– |
– |
– |
– |
|
10 |
$20,000 |
$8,000 |
|
$15,000 |
|
11 |
19,000 |
8,000 |
|
16,000 |
|
12 |
18,000 |
8,000 |
|
17,000 |
|
13 |
17,000 |
8,000 |
|
18,000 |
|
14 |
16,000 |
8,000 |
|
19,000 |
|
15 |
15,000 |
8,000 |
|
20,000 |
|
16 |
14,000 |
8,000 |
|
21,000 |
|
17 |
13,000 |
8,000 |
|
22,000 |
- What is the socially optimal number of years of education?
- You are in charge of education funding. Would you use a Pigouvian tax or a Pigouvian subsidy to induce Sian to choose the socially optimal amount of education? Justify your answer.
- How high would you set this tax or subsidy per year of education? Justify your answer.
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