ib economics extended essay

Glenforest Secondary School

Richard Bie

2203-008

Economics Extended Essay

Total Word Count: 3935

Ontarios Educated Economy: The Economic Impact of Post-Secondary Education

Richard Bie 2203-008

2

Table of Contents Table of Contents .................................................................................................................................. 2 Abstract .................................................................................................................................................... 3 Research Question: To what extent does the under provision of merit goods represented by post-secondary education contribute to an increasing loss of social welfare for students, firms, and society in Ontario? Thesis: The under provision of post-secondary education in Ontario is leading to a market failure where the tuition, economic stimulus, and the labour market are affected, resulting in a loss of social welfare to the provinces growing economy.

Introduction ............................................................................................................................................ 5 Goal and Research Question ........................................................................................................................ 5 Hypotheses ........................................................................................................................................................ 7 Evaluation of Sources ..................................................................................................................................... 8 Method and Data Collection Parameters ................................................................................................ 9

Relevant Economic Theory ............................................................................................................. 11 Market Failure ............................................................................................................................................... 11 Merit/Demerit Goods .................................................................................................................................. 11 Positive Externalities .................................................................................................................................. 12 Price Elasticity of Demand ........................................................................................................................ 13 Multiplier Effect ............................................................................................................................................ 14

Procedure/Results ............................................................................................................................ 15 Price Elasticity of Demand and Student Debt ..................................................................................... 15 Post-Secondary Education Institution Economic Stimulus ............................................................ 17 Widening gap in the labour market: ...................................................................................................... 20

Conclusion ............................................................................................................................................ 21 Limitations of research: ............................................................................................................................. 22 Additional Consideration/Further Research ..................................................................................... 22

Appendices ........................................................................................................................................... 24 Appendix A ..................................................................................................................................................... 24 Appendix B ..................................................................................................................................................... 24

Bibliography ........................................................................................................................................ 25

Glenforest Secondary School


3 Abstract

Post-secondary education is becoming increasingly under-provided in Ontario as a result

of stagnant government funding and an increasing demand from prospective students. This

research examines the following question:

To what extent does the under provision of merit goods represented by post-secondary

education contribute to an increasing loss of social welfare for students, firms, and society

in Ontario?

Due to the research questions focus on merit goods, a review of the literature on the

under-provision of merit goods as a form of market failure was outlined. While primary data was

used to understand the welfare loss for students, secondary data was used to explore the potential

loss for firms and the general public in Ontario.

Primary data was obtained from the Ontario University Application Centres archive on

yearly tuition costs and enrolment numbers to examine the price elasticity of demand for post-

secondary education. Statistics Canada provided the necessary census data to examine the

different levels of income by various education levels. The primary data were then graphically

presented and further analyzed.

Secondary information was extracted from various economic impact studies on the

importance of post-secondary education in Ontario. While it is impossible to numerically

quantify the welfare loss to society, this investigation examined the scope of the potential loss

when current trends were extrapolated for the future.

The investigation showed that there is a close correlation between the provision of post-

secondary education and the economic well being of the province. The under provision of post-


4 secondary education in Ontario is leading to a market failure where the tuition, economic

stimulus, and the labour market are affected, resulting in a loss of social welfare to the provinces

growing economy.

Word Count: 276


5 Introduction

Goal and Research Question

Post-secondary education has become one of the most, if not the most valuable asset to

any major economy in todays information age. Education matters. It matters not only to those

aspiring individuals seeking a successful career, but more importantly; education is the driving

force behind innovation and progress. The quality of Ontarios post-secondary education system

is high from both a Canadian and international perspective. However, the provinces public

university system may be facing a potential crisis as it meets the challenges of rising demand

while higher education is at a time of constrained funding. In economics, demand is defined as

the quantity of a good or service consumers are willing to buy at various price levels over a

period of time. Ontario has the largest population of students seeking higher education, but it is

also the province with the lowest funding in Canada; with per-student grants lower than they

were over half a decade ago. What this means is that the supply of post-secondary education has

not changed by much, and we can even assume that there has been no change in supply relative

to the large increase in demand. Similar to the definition of demand, in economics, supply is

defined as the quantity of a good or service producers are willing to produce at various price

levels over a given period of time. Overall, the rising demand for PSE combined with stagnant

supply means that universities are forced to make inimical compromises in order to

accommodate for an increasing number of enrolments. Evidently, as a result of the

aforementioned circumstances, there is an under-provision of post-secondary education in

Ontario.

In this research, we will analyze the potential welfare loss as a result of the under-

provision of post-secondary education for students, businesses, and the labour market in province


6 of Ontario. Thus, the raising the question: To what extent does the under provision of merit

goods represented by post-secondary education contribute to an increasing loss of social

welfare for students, firms, and society in Ontario?

With two thirds of all new jobs in Ontario requiring a post-secondary education in both

professional and skilled trade employment sectors (Ontario Ministry of Finance, 2012), the

provinces economic growth and competence will need to rely significantly on the ability of the

higher education system to continue offering quality education. In the Ontario market for post

secondary-education where the provision of the good under-cuts even the private demand, there

is bound to be considerable welfare losses to society. Such losses affect stakeholders in all parts

of the economy.

With post-secondary education institutes playing such a large role in the economy of the

province, the under provision of post-secondary education in Ontario is leading to a market

failure where the tuition debt, economic stimulus, and labour markets are affected, resulting in a

loss of social welfare to the provinces growing economy. This paper will examine to what

extent does the under-provision of post-secondary education in Ontario result in a market failure

by analyzing the potential welfare loss to the stakeholders involved.


7 Hypotheses It is hypothesized that: 1. The price elasticity of demand for post-secondary education is relatively inelastic and that with rising tuition costs, students will continue enrolling in these institutions while accruing more tuition debt. With increasing debt levels in the province, the standard of living and economic growth will decrease as a form of deadweight loss.

2. Post-secondary education institutes are also major centres for economic

stimulus within Ontarios economy as billions of dollars in government

subsidies and tuition fees enter the economy in the form of expenditures and

staff wages. Acting as such a large source of income and revenue for staff and

businesses, the well being of the provinces economy has a considerable

dependence on the money transferred from these educational institutions.

3. Due to the foreseen skills shortage as a result of retiring baby boomers in the

labour market, the economy will require a more quality and educated

workforce. The under provision of post-secondary education will cause a loss

of potential innovation for firms, diminishing the provinces overall economic

competence.


8 Evaluation of Sources

Both primary and secondary sources will be used for this research. Primary sources will mainly

consist of raw data from Statistics Canada, and various government ministries. Secondary

sources will come from various economic impact studies regarding post-secondary education.

The primary resource include:

Yearly tuition, and enrolment numbers from the Ontario Universities Application Centre

(OUAC)

Statistics Canada data on income and education

The secondary resources include:

Economic impact study of Canadian Universities by Queens University

Literature reviewing the definition of market failure and necessary definitions

Published surveys by Census Canada

Government Ministry reports

Newspaper articles

Academic journals For primary resources, OUAC is the system in which all students apply to University from in Ontario, thus the data they have is very reliable and accurate. Secondary resources from university and government reports are also credible sources as these sources demonstrate a high degree of academia and have also been peer reviewed by various scholars.


9 Method and Data Collection Parameters

The hypothesis for the price elasticity of demand (PED) for education is that it is

relatively inelastic due to the large foreseeable returns in future employment for graduates. On

average, an individual with a post-secondary education degree will earn $20 000 more per year

than those who only have high school degrees in Ontario (Martin Prosperity Institute, 2011).

Thus according to this statistic, it can be theorized that the PED for higher education would be

relatively inelastic. To more accurately determine the PED, a demand schedule would have to be

constructed from year-to-year applicant numbers in comparison to the yearly average tuition fees

in Ontario. Tuition fees will be adjusted for inflation. The yearly percentage change in the

number of applicants to Ontario universities will be obtained from primary data from OUAC and

the average yearly tuitions will also be sourced from OUAC as well as statistics Canada. The

yearly PEDs will then be added up and averaged for a given period followed by a standard

deviation calculation to ensure the most accurate data. Of course, when looking at the data we

have to assume that there have been no major changes in demographics and the student to

applicant ratio. Tuition will also reflect an inflation-adjusted value. If the PED is indeed

relatively inelastic, the student debt level will also be increasing and consequently decreasing the

standard of living, illustrating a loss in welfare.

To understand the economic impact Ontario universities have on the province, an

economic impact study by Queens university will be consulted. In understanding the economic

significance government funding has through post-secondary education institutions, a stagnant

government funding through universities and colleges will demonstrate a hindrance to economic

stimulus.


10 Lastly, to examine the magnitude of innovation loss for firms in the province, the Ministry of Finance and Labour reports will be consulted to project potential future shortages and stress the importance of providing sufficient and quality post-secondary education in Ontario.


11 Relevant Economic Theory

Market Failure In the world of microeconomics, a market failure exists when either too much or not

enough of a good is produced or consumed so scarce resources are not allocated in the socially

optimal way. The direct result of a market failure is a loss in economic and social welfare, called

a dead weight loss. For the purpose of this research paper, the loss in welfare will be analyzed in

terms of the under provision of a merit good such as post-secondary education.

Merit/Demerit Goods Post secondary education in Ontario can be seen as a merit good, which is essentially a

private good that has third party benefits attached to it. A demerit good on the other hand, is a

good that imposes costs to society when it is over produced, or over consumed. Education is a

private good due to the excludability of certain private benefits such as the higher earnings

potential from better post-degree jobs, and it is also rivalrous, available only to those who are

financially, and or academically capable. From another perspective, although higher education is

only available to certain individuals in a community, society also benefits more when more

people attend colleges, and universities. For example, the research or medical practice credited to

a graduate from a study of medicine is a significant contribution to societys healthcare system,

which is public and non-excludable in Ontario. The higher salary will solely be private, but the

societal contributions will be available to everyone. This non-measurable benefit to society is

called a positive externality, and in the case of post-secondary education, the positive externality

is a direct result of an individuals private investment in education.


12 Positive Externalities

Positive externalities are generated from the consumption of merit goods where the

marginal social benefit is greater than the marginal private benefit; hence the societal demand is

greater than the private demand. Education is a merit good in society due to its positive

externalities. In the case of both an under provision and under consumption of a merit good, a

market failure occurs. Figure 1.0 illustrates the positive externality and welfare loss that is

created out of an under-provision of a merit good

Figure 1.0 Deadweight loss from under-provision of merit good

In figure 1.0, the demand curve in this case is equal to the Marginal Social Benefit curve

(MSB). As illustrated, there are two supply curves: the Marginal Private Cost curve (MPC), and

the Marginal Social Cost curve (MSC). MPC represents the private supply of the merit good,

while MSC shows what supply society needs of the merit good to achieve and efficient

allocation of resources. Where the MPC intersects with MSB is the equilibrium price and


13 quantity the merit good is produced and consumed in the market. The price is at P1 and the

quantity demanded is at Q1. In contrast, the intersection with MSC and MSB shows the price and

quantity of the merit good society needs due to the positive externalities.

As a result in the different equilibrium price and quantity of the merit good society

demands at point a and what is actually provided at point b, there is clearly a gap formed in the

shape of the shaded triangle. This gap displays the welfare loss or in other words, the dead-

weight loss in an economy due to an inadequate quantity of the merit good. The deadweight loss

represents the loss in an economy because of an inefficient allocation of resource that fails to

provide the merit good at MSC. An economy will need to strive to diminish the area of the

triangle abc as MPC shifts rightwards and approaches MSC.

Price Elasticity of Demand Price elasticity of demand (PED) is defined as a measure of responsiveness of the

quantity demanded of a good as prices change. Mathematically, this is the percentage change in

quantity demanded divided by the percentage change in price or %"!%"!. A good is said to be relatively inelastic if the value of the PED is less than one. Looking at the equation %"!%"!, an inelastic PED means that a large change in price will result in a lesser change in quantity

demanded. Oppositely, a good is said to be relatively elastic if the PED is greater than one. In

reference to figure 1.0, since the deadweight loss is the area under the MSB curve to the MSC

and between the two equilibrium quantities, the PED of a merit good will help measure the size

of the deadweight loss as a result of under provision. In the case of post-secondary education in

Ontario, it has already been established that the MPC or supply curve can be assumed to be

relatively inelastic. The amount of deadweight loss will depend on whether the PED for higher


14 education is relatively elastic, or inelastic. If the MSB or demand curve is relatively elastic, the

deadweight loss will be more than if the demand curves were inelastic. The diagrams below

illustrate the two cases by comparing the deadweight loss in each case.

Figure 1.1 Deadweight loss PED relatively elastic vs. relatively inelastic

In figure 1.1, the deadweight loss is shown and calculated to be more when the PED is

relatively inelastic given that the supply is relatively inelastic as well. The diagrams were created

given that the quantity demanded for education by society stayed constant, with only the PED

being the variable.

Multiplier Effect The multiplier effect explains why the national income will increase by more than the increase in government expenditures. When government spending is injected into the economy, one persons spending of that money will automatically become someone elses income and as economic activity takes place in successive rounds, the overall income levels would have increased, aiding the growth of an economy.


15 Procedure/Results Price Elasticity of Demand and Student Debt When looking at enrolment numbers from the past decade, it is important to note that there was a double cohort in 2003 which was the last year Ontario had the grade 13 Ontario

Additional Curriculum. This meant that for the 2003-2004 school year, applicants to Ontario

universities included both the grade 12 and the grade 13 class (See Appendix A), rendering the

applicant and tuition statistic for 2003 and the few years following that to be outliers. In order to

gauge a more accurate calculation of the PED for post-secondary education, only the data from

2007 to 2012 will be used assuming that university admissions and tuitions have adjusted to

accommodate for the influx of applicants due to the double cohort. This will ensure that the data

is not skewed by the inflation rate.

In reference to Appendix A and B for the yearly application numbers and tuition costs, a

table was made to show the percentage changes in quantity demanded and change in price.

Figure 2.0 Change in percentage of the number of applicants vs. Average Tuition fee

Year Applicants %change Tuition (2001 dollars) %Change PED

2007 80362 4610

2008 83813 4.30 4859 5.40 0.80 2009 84691 1.00 5045 3.80 0.26 2010 87407 3.20 5270 4.50 0.71 2011 89181 2.00 5548 5.30 0.38 2012 90889 1.90 5763 3.90 0.49


16

By averaging the yearly PEDs for post-secondary education from 2008-2012 in figure 2.0, the

overall PED for higher education is calculated to be relatively inelastic at 0.53 in Ontario. A

standard deviation of 2.53 for the data also means that the average PED is with 99.06% certainty

that it is relatively inelastic at 0.53.

Using the established PED for higher education, the effects of a stagnant supply of this

merit good during a period of increasing demand can be shown in the figure 2.3.

Figure 2.1 Stagnant Supply with Increasing Demand


17 Figure 2.1 illustrates the rise in demand for higher education with supply relatively

stagnant. As D1 shifted to D2, the quantity of demand for education rose from about 83 000 to

roughly 100 000. Meanwhile, tuition price rose up from $4859 to $5763. The original

deadweight loss due to an insufficient amount of the merit good provided is shown by the grey

shaded area abc. Due to the nature of post-secondary education being relatively inelastic, tuition

will increase proportionally more than the quantity of enrolment decreasing. Students on a

student loan will therefore accumulate more debt and thus their standard of living will decrease.

From another perspective, an increase in demand in this case has lead to an increase in

deadweight loss to society for area def is far greater than area abc. While an investment in Post-

secondary education by any of the pertinent stakeholders has a plethora of positive benefits for

society in terms of skills and innovation, it is impossible to accurately put a monetary value on

the value added to an economy by a graduate. However, Universities can be seen as an Economic

Engine in terms of circulating money, which can have a more tangible impact on the economy. A

part of the increased deadweight loss embodies the loss in potential economic influence

Universities can have in their respective communities.

Post-Secondary Education Institution Economic Stimulus While the societal benefits of post-secondary education are undeniable, there also exists a

very tangible local economic benefit associated with the operation of an institution within a

community. The communal benefits can be broken down into two measurement gauges: the

salaries paid out to campus faculty, and local university expenditures. Together, the overall

economic benefit can be calculated by applying a multiplier to the money entering the market.


18 Each university provides millions of dollars in wages and salaries to the thousands of

staff that work within the institution. These incomes are then redistributed into the revenue of

businesses from everyday purchases. The full-time staff and faculty at Queens University for

example, received gross salaries of almost $200 million in 2001-02. Factoring in the part-time

payroll, as well as hospital research, the Universitys gross payroll equated to just over $278

million.

In addition to the large sum of spending on human capital, every University will also

spend a great deal more on other goods and services of local businesses. Whether its produce for

the Cafeteria, or computers for the research centres, these expenditures average hundreds of

millions of dollars annually. In another example of Queens University, the institution conducted

a local economic impact study by sourcing expenditures to local addresses in Kingston and found

that well over $34 million were spent locally on goods and services provided by almost 500

businesses in 2001-2002. Similarly in 2006-2007, the University of Windsors expenditures on

furniture, equipment, supplies, and computer technology to name a few, totalled to around $112

million (OUSA, 2009, p.9).

As the money enters the economy, it will be subject to the multiplier effect as

transactions occur. The flow diagram below shows the flow of money from an institution into the

economy.


19 Figure 2.2 University money flow multiplier

(Healey, Akerbloom, 2003, p.8)

As shown in figure 2.2, the money that is injected into Universities by government

funding flows into the economy as it is paid out to staff and businesses. While Queens impact

study on the Kingston area asserts that the institution contributes a total of $567.9 million to

local businesses and industries, the overall impact is just over $1 billion annually with the

multiplier index factored in. In other examples, the University of Brock, Waterloo, and Windsor

each contribute $265 million, $1.1 Billion, and $665 million respectively with the multiplier

included. These are examples of the economic benefits of only a fraction of the 47 publicly

funded post-secondary institutions in Ontario comprised of 23 universities, and 24 colleges.

Government investment in post-secondary education institutions is truly a powerful economic

stimulus helping students and communities across the province. Conversely, reduced or stagnant


20 funding for post-secondary education will have serious economic consequences for the overall

economy.

Widening gap in the labour market: For the current and future students enrolled in the higher education system, there is not

enough government support. The provinces working population is aging. As the baby boomer

generation advances into the age bracket of normal retirement, there will be a significant decline

in the proportion of the provinces population available to work in the prime years (15 to 64).

The projected short fall in the availability of workers is shown to rise to at least 200 000

positions, and could rise to as high as 1.8 million by 2031, depending on the changes in

demographics and population growth (Miner, 2010, p. 3). Although an under consumption of

higher education appears to be the problem, the real problem is still the under-provision of the

good. In reference to figure 2.0, it is evident that the demand for post secondary education has

been rising steadily over the years; however, if the government doesnt start increasing the

supply of post-secondary education, the demand will continue to grow and thus, the deadweight

loss will accumulate to a greater magnitude.

Failing to provide an adequate supply of qualified employees will result in slow

economic growth and hence; an inefficient market for Ontario. It has been estimated that jobs

evolve every approximately every 15 years. After that time period, positions usually occupied by

unskilled workers will become positions that will require some sort of post-secondary training

due to technological advancements or revised systems and processes.


21 Conclusion

This conclusion will review the three hypotheses stated at the beginning of the research.

The first hypothesis was the increasing student debt as a result of increasing tuitions and

a relatively inelastic price elasticity of demand. This was supported as the PED was calculated to

be relatively inelastic showing an increase in tuition price will lead to a proportionally less

quantity of applicants applying. Students will continue enrolling, accruing more debt as they

study.

The second hypothesis was that post-secondary education institutes are major sources of

economic stimulus for the province and that stagnant funding from the government will lead to

slow economic growth. Economic impact studies showed that these institutes provide billions of

dollars in wages and expenditures for Ontario when the multiplier was factored in. Stagnant

funding will directly affect the staff and businesses associated with these schools.

The third hypothesis stated that the jobs market is projected to face a large shortage of

skills in the coming years due to the retiring baby boomers and that an under provision of post-

secondary education will only make matters worse by not providing the market with enough

quality and trained skilled workers. The findings from this investigation show that there will be

an enormous skills shortage if current enrolment trends in Ontario universities and colleges

continue. This will result in a loss of innovation potential for firms, decreasing the economic

competency of the province.

The initial question can now be restated and answered.

To what extent does the under provision of merit goods represented by post-secondary

education contribute to an increasing loss of social welfare for students, firms, and society

in Ontario?


22 The research shows that the under provision of post-secondary education in Ontario is

leading to a market failure where the tuition, economic stimulus, and the labour market are

affected, resulting in a loss of social welfare to the provinces growing economy.

Limitations of research:

Although the societal benefits of post-secondary education are undeniable, the degree to

which is very subjective. Since a monetary value cannot be placed directly on the externality,

this research cannot determine the quantitative magnitude of the deadweight loss. All projected

future data is based on current extrapolated data, which also cannot consider all factors in the

economy.

Additional Consideration/Further Research If the government doesnt intervene in this market and fix it soon, society will suffer the

consequences of a highly inefficient market. To fix this market failure, the government can

further subsidize PSE, make PSE a public good, or build new infrastructure i.e. campuses to

accommodate for more interests in different areas of study. Essentially, each of these solutions is

simply shifting the supply curve to the right until it approaches the marginal social cost curve. As

the area between the two graphs get smaller, the deadweight loss is decreasing and thus fixing

the market failure.

For the future, of the economy, as the baby boomers are slowly retiring, there will

progressively be more positions available in the labour market. The government needs to

rigorously increase supply, and moderately increase demand by placing more focus on minority

groups because while demand has been displaying a steady trend of increase, supply has still yet

to show grow significantly.


23 If post-secondary education is a merit good, then we should further question to what

extent should the government subsidize the good to resolve potential future market failures. Final Word Count: 3935


24 Appendices

Appendix A OUAC yearly applicant statistics 2003-2012

(Ontario Universities Application Centre, 2012) Appendix B

Statistics Canada Average Undergraduate Tuition (1990-2009)

(Statistics Canada, 2009)


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ib economics extended essay

Documents

labour market

market failure

relevant economic theory

price elasticity of

research question

provision of merit goods

meritdemerit goods

student debt