Question

A government offers to let a number of students at a public school transfer to a private school under two conditions: It will transmit to the private school the same per-pupil subsidy it provides the public school, and the private school will be required to admit the students at a below-market net tuition rate. Will the economic outcome be the same as the one that would have arisen if the government instead simply provided students with grants to cover the current market tuition rate at the private school? (Hint: Does it matter if schools receive payments directly from the government or from consumers?)

Short answer

If government provides grants to the students then the fees will be at the market equilibrium price.

If government provides subsidies directly to schools then the fees will be below the market equilibrium price.

Step-by-step solution

Step 1. Definition of Market Equilibrium

Market Equilibrium refers to the point of equilibrium where the market demand equals the market supply for a particular commodity.

Step 2. Grant to students.

If government provides grants to the students then the fees will be at the market equilibrium price because the market supply will be the same irrespective of whether it is a public school or a private school.

Step 3. Subsidy to school

If government provides subsidies directly to schools then the fees will be below the market equilibrium price. The school will charge the student a price lower than the market equilibrium price which will increase the quantity demanded. This will result in parents valuing the services lesser.