There is no free in liberty.


Saturday, October 29, 2011

The Not So "Dark Demand" of Subsidies...


The rising  price of education  seems to keep a permanent place in the news. Why is it happening?

Just as an object approaching the speed of light incurs the cost of increased mass and energy requirements,  the closer to free a scarce thing becomes, the higher its social cost.

But ask some economists what the roll  subsidies play in the rising cost of education is and this is the sort of answer you get:

The subsidy doesn't drive up demand, it increases quantity demanded in a movement down along the demand curve. An increase in demand would indeed drive up price, but that's not what's happening here. The increased quantity demanded happens precisely because the subsidy drives the student's price downward.

The argument put forth above  expects us to accept that demand is represented by what the consumer (student) pays  when  the producer (education) charges and gets one price while the student pays a different and lower price. The reality, though, is that when the price paid by a student drops with the introduction of a subsidy, the subsidy offsets that drop in price as far as the whole of the market is concerned. The result is no change in the real price, hence no slide down the demand curve and no commensurate increase in quantity demanded.  However, there remains an apparent change in price to students which widens and deepens the market for education. The result is a shift in the demand curve and an increase in tuition prices for society as a whole.

The economist's  myopic focus on student price creates a "dark demand" for education that is represented by the dollars society spends subsidizing schools.

There is no dark demand.  Let's watch subsidies in action:

  1. You and I walk into a bar.
  2. You want a beer, but $10 is too much.
  3.  I offer to cover half your beer.
  4.  $5 bucks sounds good to you; you say OK.
  5.  Before leaving we give the barkeep $10 for the beer. (at this point many economists argue that the price of beer is $5, what you pay for your beer, while ignoring the fact that the barkeep took in $10.)
  6. Let's assume my offer to cover half the price of each beer is extended to all those individuals in the bar for not just that night but all nights that follow.
  7.  Word spreads.
  8.  The barkeep is charging $10 for each beer, yet more people want his beer.
  9.  Eventually his bar can't accommodate all the customers for his beer and he concludes $10 is too low.
  10.  The barkeep raises the price to $15 per beer.
  11.  I now pay $7.50 and the customer pays $7.50.
  12.  People are still flowing into the bar because the beer is still a bargain.
  13.  So, the barkeep concludes he needs to raise the price to $20 per beer.
  14.  I now pay $10 and the customer now pays $10.
  15.  Finally bar traffic settles down again.

Now imagine in the scenario above you are a student,  my name is subsidy, the barkeep is a school, and the beer is an education. 


  • Students initially pay less for education (beer) after the introduction of subsidies.
  • The school (barkeep) sees no change in price after the introduction of subsidies.
  • From the point subsidies are introduced the price of education (beer) rises to what the students are able to bear. (a point we a rapidly approaching today)
  • The school (bar) is the primary beneficiary of subsidies over time.
  • Subsidies never cause the cost of education (beer) for the student to rise above its cost prior to the introduction of the subsidy.
  • The cost of education (beer) doubles for society as a whole. 
  • This is not true just of beer and education, but all subsidized goods.

For the producer the effect of a subsidy on the price charged for a product  is nil. If price does not change there can be no movement along the demand curve and, hence, no change in quantity demanded. Therefore any increase in customers can only be explained as an increase in demand.

The "dark demand" of subsidies is not so dark.

Just as an object approaching the speed of light incurs the cost of increased mass and energy requirements,  the closer to free a scarce thing becomes, the higher its social cost.


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