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More on Fees and Charges

© Allen C. Goodman, 2014

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MC = MB Efficient, Always?

• In Micro principles you learn that the average cost curve is always cut at the minimum by the marginal cost curve.

• Always?• If so, MB = MC gives us

something potentially useful.

MC

AC

MB

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With perfect competition …

• Demand curve is infinitely elastic.

• Entry and exit lead to 0 profits, and we’re producing at least cost.

MC

AC

MB

MB'

MB''

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Loss

MC = MB Efficient, Always?

• But, for some types of goods, like public utilities, you have some VERY LARGE fixed costs, and very

small marginal costs.

MC

AC

MB$

Quantity

• If MC < AC, what happens to AC?

• OK. If we price at P1 = MC = MB, what will happen? Total Revenues < TC!

P1

Loss!

What happens if we price to cover average costs?

What happens if we price to cover average costs?

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Total Costs

Two (or more) part pricing• Takes advantage of the

fact that some people will value nonmarginal units MORE than the last ones. If we charge P2 for nonmarginal units, we may be able to cover more revenue.

MC

AC

MB$

Quantity

Total Revenues < TC!

P1

P2

AddedRevenue• This is done where you have

a fixed monthly fee, and then a per unit charge, like for water.

• Fisher notes that Disney parks have a single admission fee but no additional price/ride.

… although if you must wait, there may be congestion costs.

… although if you must wait, there may be congestion costs.

Loss!

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How Should We Fund Higher Ed?

• Items– Higher Ed is an investment that increases

incomes. If so, who should pay? Why?– If so, is it easy to collect the user fees? Yes it

is.

• BUT– There are other issues with paying for Higher

Ed.

Timely …No?Timely …No?

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Colleges Produce Education and Research

Suppose a college’s costs are $240 million /yr.

If they produced only education, costs would be $180 million/yr.

If they produced only research, costs would be $120 million/yr.

Pure Cost of research (PCR)= $240 – cost of ed only,

$180 or $60

Pure Cost of educ. (PCE) =$240 – cost of res. only, $120

or $120

Sum of the pure costs is PCR + PCE,

or 60 + 120 = 180!

What are the rest?

Define PURE COST = IncrementalCost of Particular Activity, so …

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Colleges Produce Education and ResearchPure Cost of research =

$240 – cost of ed only, $180or $60

Pure Cost of educ. =$240 – cost of res. only, $120

or $120

Sum of the pure costs is PCR + PCE,

or 60 + 120 = 180!

PCR = 60PCE = 120JOINT COSTS = 60

Several Issues

Research is a pretty pure public good w/ MC = 0! Why?

Costs should be and to a great extent are paid by the public sector, and not by students.

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Colleges Produce Education and ResearchPure Cost of research =

$240 – cost of ed only, $180or $60

Pure Cost of educ. =$240 – cost of res. only, $120

or $120

Sum of the pure costs is PCR + PCE,

or 60 + 120 = 180!

PCR = 60

PCE = 120

JOINT COSTS = 60

Allocation of joint costs is always an issue.

They are real costs, and they must probably be split between the funders (i.e. tuition and public).

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Students’ Full Costs > Tuition!

CategorySocial Costs Student Cost %

Instruction $16,000 $8,000 50

Books, etc. $ 1,500 $1,500 100

Foregone Inc.$ 15,000 $15,000 100

Total $ 32,500 $24,500 75.4

Students are already bearing substantial costs!

Students are already bearing substantial costs!

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Mobility and Spillovers

• Raising user costs may cause students either not to go to college, or to go to college elsewhere.

• In addition, there are spillovers of a state’s education to residents of other states.

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Universities may have large scale economies

• That is, in many situations MC << AC.

• The marginal cost (in many cases) of one more student in a class may approximate 0. Should we charge 0?

• Or should we do a two-part charge … which is often done!

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What about the poor?

• If we lower tuition, it lowers it for those who are both rich and poor.

• Alternatively, we might charge user fees, but give scholarships to the poor.

• Many state universities … and private universities do just this.

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Moving on to Ch. 9 – Grants

An example – Until 1994, in Michigan, most education spending was internally financed, generally through local property taxes.

What happened if the property in your community wasn’t worth much?

A> You didn’t collect much in taxes

What did Prop. A Do?

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Grants – Michigan, 1994

For this and other reasons, in 1994 Michigan switched to more centralized funding of education.

Taxes are sent to Lansing.Grants come back.Leads to lots of questions

Where does it come from (Washington, Lansing)?How much money will we get?By what criteria will it be given out?In what form will we get it?

Not clear in 2014!

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Types of Grants

• Specific, or categorical– For a specific purpose – you must use it for

this purpose, and for no other!– May be lump-sum ($X), or matching

(Medicaid, for example requires that the states match federal $).

• General– Revenue sharing, which is redistributive– Block grants

Impacts of Grants – General v. Matching

• Consider education spending v. all other spending.

Education

All Other

Slope = -1.0, why?

E1

A1

• Suppose that there is a lump-sum grant

• Typically it will lead to more A and more E.

E2

A2

Impacts of Grants – General v. Matching

• Suppose, instead, you were given a matching grant, where every $ you raised would be matched with a $ from the government.

• Slope is now -0.5. Why?

Education

All Other

Slope = -0.5, why?

E1

A1• Leads to much more E and relatively less A.

E2

A2

E3

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Income v. Substitution Effect

• Lump sum grant does NOT change relative prices.

• Matching grant does!

• More … next time!