microeconomics, priceI know about the effects of price controls in simple scenarios modeled with supply and demand curves, etc., but are there any general reasons why they might be beneficial (in a utilitarian sense) in practice? I am specifically wondering about the effects of the upper bound on the rates tutors may charge at my university.
Let’s start with the traditional answer: tutors are selling their time in exchange for an hourly wage. If the market for tutors is perfectly competitive, then the typical argument will show that tutors will be paid the value their marginal product (VMP). We could show that a more productive tutor will earn a higher wage, and therefore that setting an upper bound on tutor pay will distort the market. In that sense, the question is similar to a previous question: What are some general economic principles that guide CEO pay?
But, a difficulty arises when we ask what, exactly, is the value marginal product of a tutor? Let’s assume that students hire a tutor in order to increase their grades. Under this assumption, a better tutor–one that is more productive at increasing grades–will command a higher wage. But, it is not at all clear how to convert the tutor’s “grade productivity” into a VMP, and hence a wage. That we don’t really know how students optimize their study time, or how they go about valuing grades, is evidenced by the response to another question on this site: Do Students Exhibit Rational Behavior in Determining Study Time?
Let’s assume that students can determine how much they are willing to pay for tutoring that will increase their grade by a certain amount (big assumption). Then, if students understand how much the tutor can help them, they can form an accurate willingness to pay for tutoring. Tutors, due to their experience, are likely to be able to fairly accurately predict just how much they will be able to help a student. But the student might not. If that is the case, then the tutor has more information than the student. Perfect competition can break down under information asymmetry (see again the question on CEO pay). The wage cap might be an attempt to adjust for this asymmetry.
Perfect competition might break down in other ways too. For example, suppose that for a given course there are only a few available tutors to serve many students. In this case, the tutors can set a wage that is higher than their VMP (however that is assessed). While the transaction is still voluntary (and hence mutually beneficial), the tutors would be using their market power to take more of the consumer surplus than they could under a competitive market. The standard argument is that these high wages will induce more qualified people to become tutors, and that the increased supply would eventually decrease the wage.
But, I assume that there are barriers to entry to becoming a tutor who is officially listed by the university. Thus, it might be difficult for qualified people to become “official” tutors in response to the high wages. If this is the case, one possible argument in favor of the cap is that the university wants to prevent providing an indirect subsidy to tutors just by listing them as an official tutor for a course.
Finally, the university may be reasoning that the tutors are using university resources (desks, chalkboards, meeting spaces, student registries) in furtherance of their business, and that the students have already paid for these resources. They may view the wage ceiling as a market correction to internalize the cost of using university resources. This is a very common argument among university administrators (e.g. in limiting vending prices), and, while I know nothing about the case at hand, seems to be the most likely case.
Whether or not the cap is desirable is outside the domain of economics–at best, we can state that it might correct some market imperfections. We’d have to know exactly what the university’s policy objective is in order to assess the policy (see http://economics.stackexchange.com/questions/416/why-cant-or-shouldnt-economists-answer-normative-questions).
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