Price Cap and University Education

A price cap is where the Government sets a maximum price in a market that suppliers cannot exceed, in an attempt to stop the market price from rising above a certain level. The price ceiling will result in a decrease in supply and an increase in demand. Supply will fall due to the reduced supplier surplus and the demand will increase due to an increase in consumer surplus. This is represented no the graph by the change in quantity from Q1 to Q2.

When the price ceiling is lifted the market will return to a new equilibrium position. This will result in an increase in quantity supplied and a reduction in quantity demanded due to an increase in price. This resultant shift in demand will result in a reduction in consumer surplus as some consumer's willingness to pay will no longer be above the equilibrium price. Subsequently the producer surplus will rise due to the increased price and more units will be created. Despite the rise in price the consumer welfare will rise despite the welfare per consumer falling due to an increase in quantity traded.

However, higher education is not seen as a normal market by many people. Education is seen as a merit good that not only benefits the individual consuming the education but that it also benefits society as a whole. A country can benefit from an increase in productivity, growth and stability with an increase in university graduates. There are also social externalities such as an increase in innovation and a reduction in crime and prejudice. Some worry that by raising the price ceiling the demand for education will fall and so the positive externalities that result from higher education will be diminished. Because of this society is keen to encourage pupils of higher education. This encouragement is likely to help keep demand for university education high.

Whether or not the demand for higher education will fall dramatically can be answered by the markets elasticity of demand. The market of higher education has some risk. There is no way of predicting how much benefit a consumer of higher education will gain from going to university. This is unlike most products where the consumer has a good idea about the utility they gain from consumption. Consumers might be unwilling to pay large sums of money for utility that is uncertain. The utility is also delayed; this makes it more vulnerable to information failure. Consumers might undervalue the utility gained from higher education and instead opt for the next best alternative. This asymmetric information is one of the main reasons why the Government introduced the price cap into the market of higher education in the first place. Both of the above factors indicate that the demand for higher education is elastic and suggest that the increase price proposed by the Government will result in much less demand for university education.

On the other hand there is evidence to suggest that the market for higher education is not inelastic. Elasticity is heavily affected by the closeness and availability of substitutes. There are very few substitutes for university education. The substitutes are certainly not readily available and will only over a few specialised fields. In 2006 the Government tripled university fees to £3000 a year. The demand for higher education only fell in the first year that the increased fees were introduced. This suggests that the demand for university education