7. Education is an example of a positive externality: acquiring more education b

Question

7.
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.



a. Find Sian’s market equilibrium number of years of education (20pts)









b. Calculate the marginal social benefit schedule (24pts)

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? (20pts)





c. 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? (18pts)



How high would you set this tax or subsidy per year of education? (18pts)

Explanation / Answer

A) Sian will consume more education until the marginal cost exceeds the marginal benefit. At 12 years Sian will gain a marginal benefit of 18,000 and the marginal cost is 17000, at 13 years Sian would gain 17,000 but the marginal cost is 18,000 So the optimal number of years for Sian would be 12 years B) Add the amount of societies marginal benefit to Sians marginal benefit and perform the same analysis to find that the socially optimal is 16 years C) Subsidizing Sian's education would induce Sian to consume the socially optimal amount of education. D) Subsidizing it for 8000 dollars a year (the marginal social benefit) and per the preceding analysis, this would induce Sian to consume the socially optimal amount of education

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