Pell Grants: Funding Higher Education

1
Pell Grants Funding Higher Education
2
Pell Grants What are they?

• Pell Grants first appeared in 1972. They help
  fund financially needy students who are seeking
  an undergraduate degree.
• The funds go directly to participating
  institutions (colleges and universities).
• Upon receiving the funds, the institution may
  subtract the amount of the grant from the
  students bill or send the student a check.
• Students do not repay grants.
• Source King, Jacqueline E., 2003 Status
  Report on the Pell Grant Program.
  American Council on Education Center for Policy
  Analysis, 2003.

3
Pell Grants How do they work?

• To qualify, candidates must seek an undergraduate
  degree. In addition, the amount of the grant
  depends on the students effective family
  contribution (EFC), whether the student is
  enrolled part or full time and whether the
  student plans to attend school for a full
  academic year.
• Until 1992, prisoners could qualify for grant aid
  as well.
• A potential student fills out a Free Application
  for Student Aid Form, which calculates the
  students EFC.
• The EFC equals the difference between the wealth
  of the applicants family or financial supporters
  and the cost of attending school. Schools are
  classified according to whether they qualify as
  low or high cost institutions.
• Pell Grant Award Maximum Pell Grant (4,000 in
  2002) EFC
• In 2002-2003, the program aided about 4 million
  students, and the average grant award amounted to
  2,415.
• Source King, Jacqueline E., 2003 Status Report
  on the Pell Grant Program. American
  Council on Education Center for Policy Analysis,
  2003.

4
Why is the Government Involved?

• Equity Issues
• A positive correlation exists between higher
  earnings and more education.
• Poorer students may benefit more than anyone else
  by attaining higher education.
• However, demand requires a desire and an ability
  to pay. Poor students may not have the ability to
  pay for education. Society may see this as
  unfair. Since needy students may not have
  established credit (or may have bad credit), the
  government provides grants or loans at a low rate
  of interest to give needy students educational
  opportunities.

5
Externalities Associated with Higher Education
The Efficiency Issue

• A positive externality occurs when a producer
  creates benefits outside of the market while
  producing marketable goods.
• The allocation of a good that involves a positive
  externality results in an inefficiency.
• The Private Decision Rule states that a person
  will participate in a trade only if his/her
  marginal private benefit from the trade equals or
  exceeds his/her marginal private cost.
• MPBMPC
• The Social Benefit Rule states that a transaction
  is beneficial to the society only if the marginal
  social benefits from the trade exceed its
  marginal social cost.
• MSBMSC
• If the Private Decision Rule does not equal the
  Social Benefit Rule, a market failure occurs.
• Source Janus R. Mrozek (Fall 1999) Market
  Failures and Efficiency in the
  Principles Course,
  Journal of Economic Education, pp. 411-419.

6
Positive Externalities Involved in Higher
Education The Graph
Price
SMPCMSC

• B

PE

• E

• A

PA
DMSB
DMPB
QE
QA
Quantity of Education
7
Explaining the Graph

• Point A illustrates the Private Decision Rule
  where a producers MPBMPC.
• Point E illustrates the Social Benefit Rule,
  where the societys MSBMSC.
• Note that the MSBMPB. This leads to
  inefficiency.
• The size of the externality is the distance
  between points A and B.
• Not enough education is being produced. The
  distance between QA and QE signifies the
  shortage.
• The area of the triangle formed from points B, A
  and E shows the size of the deadweight loss.
• In these graphs, it is unlikely that MSCMPC. In
  fact, MSC likely exceeds MPC because of
  government subsidies. However, assume that
  MSCMPC.

8
Does Higher Education involve Positive
Externalities?

• More educated people tend to vote.
• The Facts
• In the 2000 presidential election, 52.5 of
  voters had a high school degree or equivalent.
• In comparison, 63.1 of voters in the 2000
  presidential election had some college and 77.5
  of the voters had a bachelors degree or higher.
• Voting may be characteristic of civic mindedness,
  which may benefit society. However, there is no
  market for civic mindedness.
• On the other hand, voting does not mean voters
  are informed of the issues. Uninformed voters
  may do more harm than good.
• Source Voting Participation. 2004. NCES. 8
  April 2004
• /display.asp?id88.

9
Does Higher Education involve Positive
Externalities?

• More educated people are less likely to go to
  prison.
• The Facts
• In 1997, about 87 of state inmates had a high
  school equivalent education or less.
• In comparison, about 13 of state inmates had
  some college education (11) or a college degree
  or above.
• Society benefits from fewer people in jail. It
  suggests less crimes are committed and may
  decrease court costs and the cost of housing
  criminals.
• Source Correctional Education Facts. 2004.
  NIFL. 8 April 2004
• /correctional.html.

10
Does Higher Education involve Positive
Externalities?

• More educated people are less likely to be on
  welfare programs.
• The Facts
• Temporary Assistance for Needy Families (TANF) is
  the basic welfare program in the US today.
• From October 1999-2000, only 3.4 of adult TANF
  recipients had more than twelve years of
  education.
• Not only does a correlation exist between
  education and welfare participation, but highly
  educated parents may pass their education onto
  their children.
• Source Characteristics and Financial
  Circumstance of TANF Recipients. 2004. DHHS.
  8 April 2004
• ams/opre/characteristics/fy2000/analysis.htm.

11
Subsidizing Education

• The effects of a positive externality in public
  education can be alleviated by subsidizing
  education, such as through Pell Grants.
• Subsidies will make the higher education market
  efficient only if the size of the subsidy equals
  the amount of the external benefits, so that MSC
  equals MSB.

12
Subsidizing Education
Price
SMPCMSC
PS

• B

Size of Subsidy (S)

• A

PA
DMPBS MSB
PB

• C

DMPB
Q
QA
Quantity of Education
13
Subsidizing Education

• If the subsidy is greater than the distance
  between points A and B, then too much of the good
  (higher education) will be produced.
• If the subsidy is less than the distance between
  points A and B, then not enough of the good
  (higher education) will be produced.
• The subsidy increases the price of higher
  education to the seller, PS (college
  administrators) and decreases the price of
  education to the buyer, PB (students).

14
Is Higher Education an Inframarginal Good?

• An inframarginal good is a good that produces
  external benefits or costs but does not produce
  external benefits or costs at the margin.
• Unlike normal positive externalities, the market
  of inframarginal goods can lead to an efficient
  outcome without government involvement or outside
  influence.
• The following graph demonstrates the effects of
  an inframarginal good on the market.
• The graph is similar to the positive externality
  graph. However, as the quantity of education
  increases, the MSB decreases until it merges with
  the MPB at point A.
• Since at equilibrium point E, MSCMSBMPCMPB,
  the outcome moves toward efficiency.

15
Higher Education as an Inframarginal Good The
Graph

D
16
Does Higher Education have Inframarginal Benefits?

• The college wage premium (earnings of college
  graduates/earnings of high school graduates) was
  above 1.75 in 2000. Therefore, students reap
  significant benefits for themselves from a
  college education.
• In contrast, the external benefits of higher
  education may be insignificant or immeasurable.
• Students may attend college because they enjoy
  learning, rather than as a future investment.
• Education suffers from diminishing marginal
  returns- the external benefits accrued decrease
  as more education is obtained.
• Source McConnell, Campbell R., Stanley L. Brue
  and David A. Macpherson. 2003. Contemporary
  Labor Economics. New York MacGraw-Hill Irwin.
  Page 97.

17
Inframarginal Goods and Subsidies

• If education is an inframarginal good,
  subsidizing education will lead to an inefficient
  outcome.
• This is demonstrated in the following graph.
• Point E is where MSBMSCMPCMPB.
• A subsidy increases the quantity of education
  produced and creates a deadweight loss, which
  equals the area of the triangle formed from
  points E, B and C.

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Subsidies and Inframarginal Goods
MPBEMSB
Price
SMPCMSC
MPB

• A

PS

• B

• E

PE
Size of Subsidy

• C

PB
D
QE
QA
Quantity of Education
19
Other Ways to Fund Needy Students

• Work Study Students agree to work for the
  school, and the school provides education in
  return.
• Pros Direct assess to funding
• Cons The work study program may not cover all
  costs of living. Needy students may lack extra
  time to work.
• Scholarship Students receive funding for their
  abilities/talents.
• Pros Direct assess to funding, no need to
  repay funding
• Cons Needy students may not have had the
  opportunities to develop their abilities/talents
  as much as non needy students. Scholarships may
  not directly help needy students.

20
Loans Vs Grants Facts

• During the 1999-2000 school year
• 9.2 million undergraduates (slightly more than
  half of total undergraduates) received federal
  aid.
• The average amount a student received from
  federally funded aid added up to 6,206.
• Among aided undergraduates, 40 percent received
  grants only 13 percent received loans only 26
  percent received grants and loans 8 percent
  received grants, loans, and work-study and the
  remaining 13 percent received other combinations
  of aid.
• 30 of undergraduates received some form of a
  Pell Grant.
• 23 of undergraduates received a federally
  subsidized Stafford Loan. Since it was
  subsidized, the government paid the interest.
• Students received an average Pell Grant of 2,314
  and an average Stafford Loan of 3,214.
• Source NCES Fast Facts Financial Aid . NCES.
  8 April 2004
• display.asp?id31.

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Loans Vs. Grants Pros and Cons
Loans Pros Students can get more money from
loans than grants, relatively easy assess to
loans if federally insured, government may
subsidize interest on loans, middle class
students who do not qualify for grants may
qualify for loans Cons Student defaults cost
the government more than two billion dollars a
year, high middleman costs from obtaining a loan
from a bank, needy students are already
financially pressed, so why add to their
debt? Grants Pros No cost of going through
banks or a middleman, no costs of trying to
collect on debt, more practical for extremely
needy students Cons Marginal cost of collecting
grant money from taxpayers may exceed the
marginal benefit One possible solution By
fixing the loan payments according to a
percentage of future job earnings, the government
could decrease loan defaults. However, this may
be difficult and costly to enforce. Also, it may
discourage students who expect high paying jobs
from getting a loan. Source Flint, Thomas A.
Predicting Student Loan Defaults. The
Journal of Higher Education, Vol.
68, No. 3 (May-June, 1997), 322-354.
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General Problems with Funding Higher Education

• How do we know whether higher education involves
  more positive externalities or more inframarginal
  benefits?
• It is difficult to measure the externality.
• Without knowing the size of the externality,
  subsidies from the government are unlikely to
  lead to an efficient allocation of resources.
• Redistribution is a problem. The source of
  government funding for education of the poor may
  come disproportionately from the poor.

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Conclusion

• Despite the problems of funding higher education,
  grants and federal aid provide a way to reduce
  equity and efficiency problems if they are used
  effectively.
• Pell Grants provide needy students with a means
  to fund their education without increasing their
  debt.
• All government aid involves costs and benefits.
• Different types of aid serve different types of
  needs. For example, it seems fair that the
  neediest students should have access to grants,
  since the neediest students are the least able to
  pay. On the other hand, loans often provide
  funding for students with relatively more income
  support but who still cannot finance the cost of
  college without help.