Wednesday, December 13, 2006

Why Is College Tuition So High?

Economist Greg Mankiw has a great post on his blog about why college tuition has risen so much in the pst few decades. He gives 3 possible explanations:

1. Increasing costs due to Baumol's cost disease (which I explained in this earlier post).
2. Higher demand for a college degree since the wage gap between college-educated and non-college educated workers has been increasing.
3. Price discrimination means that the published tuition is not really the price that most students are paying. So the average price that a student is paying is much lower. And the increase is due to increasing skill at price discriminating

This topic is very relevant to you guys since you and your family will start paying these tuition fees in about a year. Any other possible reasons you can think of? Which one of these reasons do you think explains most of the increase?

Another Example of the Peltzman Effect

At the beginning of the year, we read an article about how when seat belts became mandatory in cars, people started to drive more dangerously, countering the effect of seat belts. Here is another example of that so-called Peltzman Effect: the NY Times magazine reporting on research that motorists drive closer to people on bicycles when they are wearing a helmet.

(Source: Newmark's Door)

The Economics of Hidden Fees

The NY Times has an article on hidden fees, where the stated price of the good does not reflect the full cost. Examples are ATM surcharges that you may not know about when you open your bank account, expensive minibars in hotels where you don't know that you are paying $4 for a Coke until you get the hotel bill, or expensive printer cartridges you have to buy every month for a printer that you got on sale.

The main question the article asks is: why don't firms compete to offer low ATM surcharges or low printer cartridge prices? A firm could offer their printer cartridges or minibars at lower prices and advertise those lower prices to increase their business.

The article references a paper by two economists that argue that it is a form of price discrimination (even though they don't use that term in the article):

Their argument assumes the existence of two kinds of consumers — sophisticates and “myopes.” Sophisticates play the hidden-fee game well. They seek out low advertised rates and whenever possible avoid or find substitutes for the hidden fees, using cellphones at hotels, steering clear of the minibar and setting their printers to draft mode. Myopes, by contrast, obliviously sip $5 Cokes.

Now ask yourself: what would happen if some business tried to blow the whistle on hidden fees in its sector? Consider a hotel chain that wants to expose the use of hidden fees by, say, the Hilton chain. Because Hilton makes so much on the extras, it can charge a low, even a loss-leader, price (say, $80) for its rooms. The other chain might charge more (say, $100) as it hits the airwaves with ads saying: “Watch out for our competitor’s hidden fees. We charge fairly for breakfast and local phone calls.”

But now ask yourself: whose behavior would such an ad change? Sophisticates already know about the hidden fees. All that the ads will do, Laibson and Gabaix contend, is turn some myopic consumers into sophisticates. And in turn these newly wised-up consumers will spend less on extras at both hotels — indeed, at any hotel they use from then on. Unshrouding hidden fees is “good for the consumer and bad for both firms,” Laibson and Gabaix conclude. “Neither firm has an incentive to do it.” Multiply the hotel example by a thousand, across all sorts of industries, they say, and you see how we got the countless deceptive price structures we have today.

Any other examples of hidden fees? What do you think of the author's argument? Are you a "myope" or a "sophisticate"?

(Source: Marginal Revolution)

Marginal Tax Rates in the US

Here is a graph of the top marginal tax rate in the US tax system over the past century or so.

A couple of things to notice:
- the decrease of the highest marginal tax rate during the 1920s and the subsequent increase of that rate during the Great Depression

- the decline in the highest marginal tax rate over the past few decades

Richard Posner argues that this decrease in the highest marginal tax rate helps explain the increasing income inequality in the United States:
What are the causes, and what are the effects, of this trend in the income (and of course wealth) of the highest-earning segment of the distribution? Part of it is reduced marginal tax rates, because high marginal tax rates discourage risk-taking. Consider two individuals: one is a salaried worker with an annual income of $100,000 and good job security, and the other is an entrepreneur with a 10 percent chance of earning $1 million in a given year and a 90 percent chance of earning nothing that year. Their average annual incomes are the same, but a highly progressive tax will make the entrepreneur's expected after-tax income much lower than the salaried worker's. Many of the people at the top of the income distribution are risk takers who turned out to be lucky; the unlucky risk takers fell into a lower part of the distribution.
Economist Greg Mankiw adds:
Has the fall in top marginal tax rates over the past several decades in fact encouraged people to pursue higher-risk career paths, thereby exacerbating inequality in ex post incomes? As far as I know, this hypothesis has not received much attention in the empirical literature on income inequality.
(Source: Greg Mankiw's Blog)