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Economics 101: Basing tuition on supply, demand

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Economics experiments are rare in democratic societies. What we do see, though, are economic policy decisions that, often unintentionally, look a lot like uncontrolled economics experiments.
Recently there were announcements of two of those policy decisions: one in California and one in Europe.
Economics is more of an observational science than an experimental one and there is no recognized body of knowledge called "experimental economics." There are several reasons for this, each in its own way enough to discourage experiments.
The first is that economics is a social science. It is about people, and most people do not like being experimented on. The second reason is that it is nearly impossible to control the variables in an economics experiment, which makes the results of the experiment essentially useless.
A third good reason is that economic experiments in the real world often produce "blowback" that, in a market-driven economy, can be costly for the experimenting organization.
The cumulative effect of these reasons has been to limit economics experiments to classrooms where students play cleverly designed "let's pretend" games that supposedly mimic real economic transactions. Professors then interpret the results as having some sort of deep meaning, with implications for economic theory and policy. For the most part, these experiments are not all that relevant to economics but instead are an academic rendition of Willy Wonka's mangled observation: "So much time; so little to do."
As good as the reasons are, they haven't stopped policy makers from experimenting. This is not necessarily a bad thing, but we should always prepare ourselves for unexpected results.
One very interesting experiment in rationing is underway at Santa Monica College, in California. Despite the overall decline in community college enrollment in the state, Santa Monica is facing a surging demand for courses required for transfers to four-year institutions and for courses required by job training programs. The college, though, lacks the resources to increase the supply of those courses to meet the demand.
This is a classic economics problem that in most markets is resolved by price increases. Supply and demand are brought back into balance by increasing the price until the quantity demanded is equal to the quantity supplied. It isn't always a pleasant experience for the demand side, especially for products, like gasoline and heating oil, we consider to be necessities. But it works to balance the market.
Santa Monica College administrators have decided to introduce a two-tiered tuition system in which additional high-demand courses would be offered – at a higher price.
It is not just a little bit higher, either. The current tuition cost at Santa Monica is $36 per credit hour. The demand-based cost will be $180 per credit hour.
The proposal, which has already sparked student protests and could still be axed by the California's Community College authorities, raises some questions of whether a price-rationed supply system is the right way for an educational institution to resolve supply-demand imbalances.
It also raises questions about whether a three-tiered system would be better. The college could, for example, offer to allow students to register for a high-demand course, not attend any classes, and pay the regular tuition and take the final exam for credit. This would allow students to pursue tutoring, individually or in small groups, as a substitute for regular class attendance.
The second policy decision, in Europe, focused not on price rationing but on preserving competition in an "oligopoly" – a market with few suppliers. This, also, is a classic situation in economics, especially in mature markets such as petroleum and finance.
The Finance Ministers of the European Union (EU) decided last week that it would be a good idea for bond issuers to rotate credit rating agencies every three years. Bondholders, though, quickly deemed this idea impractical, given the amount of time it takes to sort out the risk factors in a bond issuing institution. Faced with this unexpected result, the EU promptly issued a "never mind" and sent its proposal back to the drawing board. From an economics standpoint the issue remains important and interesting, with significant implications for the U. S. economy, but we will have to wait a while to see how the story comes out.
For U.S. policy makers, and all of us, really, interest in the outcome of Santa Monica College's economics experiment in price-rationing goes well beyond California's borders. We face a similar demand-supply imbalance in health care, the outcome of which will almost certainly be rationing of some sort.
None of the current plans, including Obamacare, directly addresses this imbalance, so it will be especially valuable to see the public and political reaction to a price-based rationing solution. In a sense it will give us a glimpse of the future.
James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for the Snohomish County Business Journal.
Story tags » Economy, Business & FinanceColleges



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