The theory of inter-temporal choicetells us that students should be willing to invest in higher education in order to acquire greater future earnings. Can this help economists decide at what level fees should be set? Discuss
The theory of inter-temporal choice tells us that students should be willing to invest in higher education in order to acquire greater future earnings. Can this help economists decide at what level fees should be set? Discuss the limitations of this theory as it applies to the market for higher education.
Inter-temporal choice illustrates the affects of consuming a commodity currently at this time or saving this consumption for a future time period. The maximum consumption any one person could consume at a given time is given by a person's current income (savings) plus the maximum amount you can borrow against your future income; this is referred to as permanent income. However it can often be hard to predict what your future income will be. Will the potential of earning extra income after university be greater enough benefit to encourage a student to go to university? In going to university a student has to consume (c1) relatively heavily given his small current income in this period (m1). It is common for a student to borrow money against his life income, as his first-period consumption is greater than his first-period income:
c1> m1
The money which has been borrowed has to be paid back with interest, we will call interest r. From this the following budget constraint of the student can be derived for period 2 (C2), in the future:
C2 = m2 - r (c1 - m1) - (c1 - m1)
= m2 + (1 + r) (m1 - c1) (Varian)
As can be seen from this constraint if consumption is high in this period and income is low, (m1 - c1), a student has to borrow money off his future consumption in period 2, future income will have to be invested to pay off this debt:
It seems that students shouldn't go to university as they will simply be getting themselves into debt and be forced to pay off there debt in future consumption periods. Furthermore Consumption in period c1 has a higher price than future consumption because the opportunity cost of the interest is lost when the money was spent and not saved. However this tells us nothing of a consumer's preferences over current and future consumption, how much would is the student willing to borrow in order to attend higher education, how much saving would a student be willing to trade off ...
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It seems that students shouldn't go to university as they will simply be getting themselves into debt and be forced to pay off there debt in future consumption periods. Furthermore Consumption in period c1 has a higher price than future consumption because the opportunity cost of the interest is lost when the money was spent and not saved. However this tells us nothing of a consumer's preferences over current and future consumption, how much would is the student willing to borrow in order to attend higher education, how much saving would a student be willing to trade off for his higher education and what benefits do higher education give?
Nearly all students, and people alike, are willing to substitute some consumption from one time period in the future to fund consumption in another; a student chooses to consume higher education. The amount he is willing to substitute depends on the individual's consumption preferences, the patterns of how he likes to consume and which period of consumption gives the best returns of investment. On the micro scale it can be hard to predict what level to set the fees at as all individuals' value their degree differently, the opportunity cost of not going to university varies for different students, some students may be entrepreneurial and may feel a degree won't help their future income in future periods (m2). A degree doesn't automatically give you a job at the end and if fees increased some slightly pessimistic students may feel the pay off from saving income rather than consuming it on larger fees would be greater. It may result in some of the more academically gifted students not wishing to pay the increased costs and also the greater interest payments of obtaining the status of a having a degree, therefore choosing to substitute away from paying fees and going to university. Higher education is a specialist field there are a finite number of people with the ability to read certain courses, in creating extra constraints for those people able to come to university there may be a shortage of students to read certain courses if student fees were increased.
If we re-arrange the equation on the previous page to:
(1 + r) c1 + c2 = (1 + r) m1 + m2
It can clearly be seen that investing some of your income from period 1 instead of consuming it, results in the value of that money increasing in period 2 simply due to the interest (r) which you receive from the bank. This is the interest which students are losing by consuming further education, as I have mentioned earlier. A student therefore should invest in education, human capital investment, 'if the expected return from the investment is greater than the market rate interest.1'
We now need to predict the expected rate of return from receiving higher education, a student reads at university not only to increase his academic knowledge but from previous data taken of students, who are now retired, there wages tend to be higher than those people who didn't take part in higher education:
As can be seen from this graph those who choose higher education make a loss in this time period. However, when they leave their income increases at a much faster rate and after approximately thirty, students on average tend to be earning more until they retire at age sixty-five. So there net earnings over their life do tend to be higher, can a percentage of this extra average wealth that students earn from higher education be taken and converted into paying university fees, while obviously taking into account the effects of interest and not having so much income to save earlier in your life. This could be done, but it ignores so many other factors which need to be considered. For example the data used to compile student incomes after university will be old and out of date, a student's permanent income has to be known and this requires for an ex-student to have retired, when that pensioner was a student was roughly 42 years ago. In the last forty years there have been huge advances in technological initiatives, how will this affect the unemployment rates, if unemployment rates are higher there will be greater competition for employment in the market and wages will drop accordingly leading to smaller permanent incomes. The benefits obtained from higher education may not only affect the individual but also may have effects on the whole economy by increasing outputs for businesses. There is a social return that has to be considered, this is again difficult to obtain empirical data for. Furthermore, over the course of the twentieth century there have been two economic shocks to the economy, the First and Second World War which created inflation as in the 30s and 40s and altered the real value of incomes which in turn creates more obscurities to the overall permanent income of past students.
Different courses tend to have contrasting effects of a student's consumption in future periods, a law or medical degree may have greater prospects for a higher paid future income than a degree in David Beckham. I don't believe it is fair to discriminate between degrees forcing students reading law to pay more than students reading David Beckham, even if they are reading at the same university, as it discourages diversity at university.
To conclude I do believe inter-temporal choice can help with setting future university fees but it can only be used as a guide and can't be the only peace of theory used in this process. There are so many other factors that have to be considered such as the social impacts, are past permanent incomes accurate, different degrees read obtain different levels of future income, the effects of new technology to the unemployment rates and an individual's preferences vary from one person to the next.
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Bibliography
Distinguished Fellow: Mincering Labor Economics The Journal of Economic Perspectives, Vol. 6, No. 2. (Spring, 1992), pp. 157-170.
Blundell, R, Dearden, L, C Meghir, and B Sianesi (1999) "Human Capital Investment: the Returns from Education and Training to the Individual, the Firm and the Economy", Fiscal Studies, 20(1) 1-23
Varian Chapter 10
Blundell, R, Dearden, L, C Meghir, and B Sianesi (1999) "Human Capital Investment: the Returns from Education and Training to the Individual, the Firm and the Economy", Fiscal Studies, 20(1) 1-23
