A government offers to let a number of students at a public school transfer to a

Question

A government offers to let a number of students at

a public school transfer to a private school under

two conditions: It will transmit to the private

school the same per-pupil subsidy it provides the

public school, and the private school will be

required to admit the students at a below-market

net tuition rate. Will the economic outcome be the

same as the one that would have arisen if the government

instead simply provided students with

grants to cover the current market tuition rate at

the private school? (Hint: Does it matter if schools

receive payments directly from the government or

from consumers?)

Explanation / Answer

No, the outcome will be different. If the government
had simply provided grants to attend private
schools at the current market tuition rate, parents
and students receiving the grants would have paid
a price equal to the market valuation of the last
unit of educational services provided. Granting a
subsidy to private schools allows the private
schools to charge parents and students a price less
than the market price. Private schools thereby will
receive a higher-than-market price for the last unit
of educational services they provide. Consequently,
they will provide a quantity of educational services
in excess of the market equilibrium quantity.
At this quantity, parents and students place a
lower value on the services than the price received
by the private schools. Public schools will lose
students to private schools. The prices that public
schools receive will also decline. Both of these
changes will result in lower revenues for public
schools.

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