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Part 4 The Economics of Education

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1 Part 4 The Economics of Education

2 Introduction The US education crisis?
US and a sample of world countries What? Input output relation Comprehensive analysis of the crisis need to address the following areas: Who provides education? Analyze the market for education Rationales for intervention Government failure How is education financed? Centralized v decentralized

3 Introduction How significant are school resources to achievement
Education production function Role of: peers, teachers, home environment, curriculum, resources Is there an achievement gap within the US? Inner city v suburban schools? Why? Significance of externality from peers Effect of urban segregation on the gap and the average achievement Sheff v O’Neil and reform measures Placing the US in international context

4 Education as a Publicly Provided Good
K-12 education is delivered in a system of primarily public education 90% of school aged children in the US attend public schools

5 International Comparison of Education Expenditure
Country Expenditure /student ($) Expenditure as % of GDP United States 8855 3.5 Norway 8476 3.9 Italy 7218 3.2 Australia 6894 Sweden 6339 4.9 Japan 6266 2.7 Netherlands 5912 International Comparison of Education Expenditure

6 Free Market for K-12: Demand side
No public schools and no regulation requiring school attendance Value placed on education: Additional earning to the individual as a result of extending education Better decision making Interpersonal relationships Pure satisfaction from learning

7 Free Market for K-12: Supply Side
On the supply side we assume: The market is perfectly competitive No externalities in production (MSC=MPC) Constant marginal cost

8 Market for K-12 $ Demand Supply (MC) $5,000 Q equilibrium Quantity

9 Externalities from Education
Positive externalities in consumption: the benefits from education spill over to a third party Positive externalities from: More rapid economic growth Better functioning democratic process Better safety and hygiene Greater charitable contribution Better decision making and more efficient functioning of markets

10 Externalities From Education
Consumer 1 1 1 1 10 Marginal social benefit > Marginal private benefit

11 Magnitude of Spillovers
The absolute size of the positive externality declines as a student progresses through K-12 education. Evidence: The greatest externality occurs during the earlier years of education What does that imply about the shape of the MSB curve?

12 Externalities From Education
$ MSB 2 Demand The spillover effect is relatively small. The MSB is given by MSB2 The market for education is efficient $5,000 Supply (MC) Q equilibrium Quantity

13 Externalities From Education
$ MSB 1 Demand The spillover effect is relatively large. The MSB is given by MSB1 The market for education is inefficient $5,000 Supply (MC) Q equilibrium Q optimal Quantity

14 Externalities From Education
$ MSB 1 Demand A subsidy of $1000 Supply (MC) $5,000 Supply (MC) with the subsidy $4,000 Q equilibrium Q optimal Quantity

15 Imperfections in the Capital Market
A child’s education as an investment Return later in the child’s life Not possible to use human capital as collateral to secure loan to finance education Financial institutions offer loans at a premium The higher than social cost of funds discourages spending on schooling

16 Absence of a parent-child contract
A child consumes education when he does not have the means to pay Parents more likely to finance the education of a child if the child commits to repay them in the future No such contract Parents are likely to underinvest in a child’s education

17 Rationale for government provision
Does the need to ensure the provision of quality education justify government intervention? No Given the availability of information, the market will supply quality goods. Demand will adjust to provide quality education. If information is not available, the government can simply require information disclosure

18 Rationale for government provision
Do the positive externalities from education justify government intervention? Yes A subsidy that equates the MSB with the marginal cost can correct the market failure However, the existence of the externality does not necessitate public provision of education

19 Rationale for government provision
Does the need for Social and Cultural Cohesion justify government intervention? Yes US population is very diverse The need to share common experience to avoid breaking apart along those differences K-12 system as a melting pot Builds a shared moral framework that can hold society together

20 Rationale for government provision
Does the need for Social and Cultural Cohesion justify government intervention? A private education market will lead to Schools that do not necessarily perpetuate important cultural values, e.g., tolerance, equality Provision of a differentiated product: schools distinguished by a cultural, racial or religious character Segregation: schools have children with similar backgrounds Unequal opportunity for success as high income families have more options.

21 Government failure Hoxby (1996) analyses the challenges of financing public schools Intervention in the education market does not necessarily result in the optimal consumption of education Inefficiencies typically present with government provision Free riding: as with any publicly provided good and especially by parents who do not have children Moral hazard: individuals will free ride when the government commits to providing a minimal amount of education- safety net

22 Centralized v. Local Finance
How does the government finance education? Local finance Taxes collected from a certain district Used to finance local public good Tax rate determined by the district’s median voter Centralized finance Taxes imposed on statewide or nationwide tax base Redistribution across states: A district gets a share of the tax money, not necessarily equal to money collected from that district Tax rate determined by the state’s median voter A district has little control over tax rates or provision of public good

23 Advantages of Local Finance
Efficient: in combination with the Tiebout (1956) process individuals choose the tax rate and size of public good to match their preferences by moving across districts- no under provision Reduces capital market failure: parents finance 12 years of schooling through lifetime taxes Solves a principal (tax payers)-agent (school administrators)model Households unable to verify school outcome Property values direct measure of unverifiable school outcome Higher tax revenues from increased property values

24 Possible Problems of Local Finance
Fiscal spillovers: When taxes based on property values, people in low valued houses can free ride the median voter chooses a level of school spending that is lower than if the district was homogenous Answer: Can be solved using zoning regulation Results in human capital segregation Centralized finance leads to human capital integrated schools Answer: People will sort themselves Tiebout style if there is high correlation between demand for human capital and human capital

25 The Education Production Function
Empirical evidence indicates that: increasing school spending has a modest impact on achievement. Urban schools spend more per student than suburban schools yet the achievement gap persists Questions: What is the nature of the relationship between school spending and achievement? What variables determine achievement? Do scores capture educational output?

26 Education Production Function
How to measure achievement? Lifetime income Scores on standardized tests Graduation rates

27 Education Production Function
Factors affecting achievement: H: Home environment P: Peer group C:Curriculum E: Education resources T: Teacher quality Marginal gains in achievement will decrease with an increase in a single factor, holding other factors constant

28 Empirical Evidence Home environment:
Depends on parent income and education Educated high income parents: encourage studying, provide extra help and discourage distracting activities offer needed medical care: 50% of low income children have vision problems that interfere with their education Offer stable housing: 30% of low income children attend at least 3 different schools by third grade- only 10% for middle class kids Offer safe housing Nurturing preschool environment: Shonkoff and Phillips (2000): early childhood development has a strong impact on the ability to acquire skills which amplifies differences in school achievement

29 Empirical Evidence Externalities from the peer group
Favorable peers are smart, motivated, not disruptive Evidence that peer effects most important for grades 5-12 Placing a high achiever in a class of low achievers: Sund (2009) shows that low achievers have the most to gain so class average increases Placing a high achiever in a class of medium achievers: Burke and Sass (2008) shows that class average increases China, Ding and Lehrer (2007) show that medium achievers gain more (suggesting an increase in class average) than low achievers from the presence of a high achiever (which results in a decline in class average)

30 Empirical Evidence Teacher quality: Significant variation in quality
Quality measured by: student scores, education, experience and communication skills productive teachers have superior communication skills Graduate degrees don’t significantly affect teacher quality Hanushek (2010) and Chetty et. al.(2010): Replacing an average teacher with a superior teacher increases student score 50th percentile to 58th and increases lifetime earning/student by $21,000 Hanushek and Rivkin (2010): if we replace the bottom 8% of teachers by average teachers, test scores increase by 45%, eliminate international achievement gap, increases GDP by $112 trillion

31 Empirical Evidence Boyd (2005) a “draw of home” tendency
In cities more openings than qualified applicants means the need to import suburban raised teachers. Only lower quality suburban teachers accept Lower quality of school building, noise, ventilation In cities higher teacher turnover

32 Empirical evidence Class size
Smaller classes result in higher test scores Largest benefit to minority groups Krueger (1999): reducing class size by 1/3 for 4 years: Extra cost $7400/ student Increase in lifetime earning per student $9,603 for men and $7,851 for women Benefits and costs within the same ball park

33 Other Empirical Evidence
Coleman (1966): the first cited. Variation in school resources (teacher student ratio, spending per student, library) has an insignificant effect on the gap between while and black children Literature on effect of spending on scores has mixed results: Krueger (1997): smaller classes matter to minority Hanushek (1997): no significant effect Hoxby (2000): using data from Connecticut also finds no effect.

34 Other Empirical Evidence
Rothstein (2004) examines inequality in school spending: Interstate Inequality: Range: 159% of the average in New Jersey to 61% in Mississippi. Variation in states ability to pay Federal funds 7% of school expenditure, limited ability to equalize spending Inter district inequality: due to property tax system. NY, WY, IL have the largest gaps. State funding sometimes used to equalize gaps: for example, MA spends $8, 416 in high poverty areas and $7,946 in cities and towns with fewest poor

35 Achievement gap Due to the challenges facing urban schools a gap exists between rich and poor, white and minority: According to Standard and Poor (2006) reading proficiency on NAEP exam in 2005: Asians 39%, whites 37%, Blacks 11%, Hispanics 14% Economically disadvantaged 15% compared to 38% those not According to Urban Institute (2004), high school graduation rates: Suburban 73%, central city 58%, largest gap in New York, lowest rates for minority

36 Reform: History The gap is caused by housing segregation, location and local funding De jure segregation up to 1954 laws required separation of black and white children across schools Brown v. Board of Education Court overturned the precedent requiring integration De facto segregation: Schools continued to be segregated even in the absence of segregation laws

37 Reform: School structure
Concerns about the quality of education By 1970 greater equity in distribution of school resources Concern about gap between US and other countries: National Commission on Education Excellence concerned that the US falling behind due to teacher quality, training, not enough homework, length of school day Need for competition: monopoly of local schools results in very little improvement in quality

38 Reform: Competition Magnet Schools Charter schools
Specialized curriculum, new approach to learning Tacoma 1968 and Boston 1969 Accepted by courts to address issues of segregation Charter schools Established privately Funded by government St Paul, Minnesota 1992

39 Reform: Accountability
Standards movement: Emphasized lack of accountability No Child Left Behind Act School districts develop criteria to measure performance Test each year Identify schools needing improvement Sanctions to failing schools: losing students, changing management, losing funds

40 Reform: Accountability
Problems with No Child Left Behind Act Output of the education production function Standardized tests do not adequately test learning Teaching to the test Limited budgets: improvement to test scores achieved by cutting funding from extracurricular activities Scores also depend on student background and social factors Harder for inner city schools to meet the standards

41 Reform: School Choice Allow families to choose beyond the what is assigned Bring elements of the free market into education Families can choose Competition between schools improves quality Problems with school choice Who are the choosers? Self selection: educated and wealthy families will exercise the choice Access to information Can afford to pay extra under a voucher Those left behind Choice based on proximity to residence or work or based on composition of student body Introduces more divisions in society

42 Effectiveness of the Reform
Effect on: International gap Inner city suburban gap Empirical Evidence: Hoxby (2004): Charter students more proficient than student attending district school 3.8% in reading 1.6% in math Carnoy et al. (2005) and Roy and Mitchell (2005) find no significant difference: Control for income and race In general mixed results about the success of charter schools

43 Effectiveness of the Reform
Empirical Evidence: Gil et al. (2001) finds small gains to minority student from voucher program National Center for education statistics: children in public schools do as well after controlling for demographic variables Blueston (2008): parental background and community factors are significant

44 Reform

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