Economics and Contemporary Issues

9th Edition McLean Test Bank

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Chapter 9—College Education: Is It Worth the Cost?

TRUE/FALSE

1. The present value of a sum of money is greater than the future value of that sum.

ANS: F PTS: 1

2. An investment is worthwhile if the sum of the present value of benefits exceeds the sum of the present
value of costs.

ANS: T PTS: 1

3. An investment should be undertaken if the market rate of interest exceeds the rate of return that can be
earned on the investment.

ANS: F PTS: 1

4. The principal costs a student incurs while pursuing an education are tuition, books, supplies and
income foregone.

ANS: T PTS: 1

5. The annual income that could have been earned by investing the funds that were used for a college
education is part of the opportunity cost of attending college.

ANS: T PTS: 1

6. Increased income is a benefit of a college education that is not easily valued in dollars.

ANS: F PTS: 1

7. The benefits of a college education that are not easily valued in dollars are estimated to be quite small.

ANS: F PTS: 1

8. Overeducation occurs when college graduates believe they are overqualified for their jobs.

ANS: T PTS: 1

9. Increased access for students from lower-income families is one of the arguments used to justify
government financial support of higher education.

ANS: T PTS: 1

10. The social benefit of a college education is greater than the individual student benefits.

ANS: F PTS: 1

11. The spillover benefits of a four-year college education are quite large.

ANS: F PTS: 1

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 12. The government guarantee on student loans helps to overcome credit market failure.

ANS: T PTS: 1

13. Money appropriated by state legislatures for instructional purposes is the largest source of subsidies to
college students.

ANS: T PTS: 1

14. Spillover benefits can easily be value.

ANS: F PTS: 1

15. Pell grants are an effective means of encouraging low-income individuals to enroll in college but have
little effect on middle and high-income individuals.

ANS: F PTS: 1

16. Evidence indicate that Pell grants have had little impact on enrollment by low-income students due to
their lack of means to finance the remainder of the costs.

ANS: T PTS: 1

17. Social rate of return for a four-year college education is slightly higher than the student rate of return.

ANS: T PTS: 1

18. State appropriations to state colleges and universities greatly benefit students in more comprehensive
universities than in junior colleges.

ANS: T PTS: 1

MULTIPLE CHOICE

1. In order for an investment to be worthwhile:

a. the present value of costs must exceed the present value of benefits.
b. the present value of benefits must exceed the present value of costs.
c. costs must exceed benefits.
d. benefits must exceed costs.
ANS: B PTS: 1

2. In order for an investment to be worthwhile:

a. benefits must exceed costs.
b. costs must exceed benefits.
c. the market rate of interest must exceed the rate of return on the investment.
d. the rate of return on the investment must exceed the market rate of interest.
ANS: D PTS: 1

3. Which of the following is an example of a benefit of college education that is easily valued in dollars?
a. reduced crime rates.
b. higher fringe benefits.

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 c. increased research and development.
d. increased earnings.
ANS: D PTS: 1

4. Which of the following is an example of a cost or benefit of college education that is not easily valued
in dollars?
a. the increased earnings associated with a college education.
b. the earnings foregone while in college.
c. the enhanced value of leisure.
d. money paid for tuition.
ANS: C PTS: 1

5. Which of the following is an example of an opportunity cost of attending college?

a. The money you pay for the books required in your college classes.
b. The annual earnings that could have been had by investing the money for college
elsewhere.
c. The money you pay for tuition while attending college.
d. The part of your college fees that go to support the student health center on your campus.
ANS: B PTS: 1

6. Studies indicate that the benefits of a college education that are not easily measured in dollars:
a. are negligible.
b. increase as the number of years in college increases.
c. may be as great as the benefits that are easily valued in dollars.
d. are more important for males than females.
ANS: C PTS: 1

7. In general, economists feel that the external benefit of:

a. crime reduction that occurs as a result of a college education is quite large.
b. research is generated primarily from advanced degrees.
c. artistic events, such as plays, is nonexistent.
d. research undertaken by colleges outweighs the external benefit of crime reduction.
ANS: B PTS: 1

8. The external benefits of a college education:

a. are relatively small.
b. are relatively large.
c. are greater for undergraduate than graduate work.
d. are greater than the external benefits of a secondary education.
ANS: A PTS: 1

9. The rate of return is defined as:

a. the discount rate that makes present value of costs equal to present value of benefits.
b. the discount rate that makes the present value of net benefits greater than 1.
c. the discount rate that makes present value of benefits greater than the present value of
costs.
d. the discount rate that makes the present value of net benefits less than 1.
ANS: A PTS: 1

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10. Which of the following are used to rationalize subsidies to college students?
a. College graduates are less likely to engage in criminal behavior.
b. Subsidies ensure low-income students greater access to higher education.
c. A college education may increase the value of one's leisure time.
d. Children of college graduates may experience greater levels of intellectual development.
ANS: B PTS: 1

11. Federal money awarded to college students on the basis of need is known as a(n):
a. tuition subsidy.
b. appropriation.
c. Pell grant.
d. guaranteed student loan.
ANS: C PTS: 1

12. The major subsidy provided by states to college students is:

a. state appropriations to state colleges and universities.
b. grants.
c. guaranteed student loans.
d. state funded scholarships.
ANS: A PTS: 1

13. Which of the following are put forth as reasons to provide subsidies to college students?
a. Subsidies are needed to compensate students for the external benefits created by their
college education.
b. Subsidies are needed to increase the access of low-income individuals to higher education.
c. Subsidies are needed to correct for capital market failures.
d. All of the above.
ANS: D PTS: 1

14. Nonmonetary spillover benefits of a college education include:

a. Research spillover.
b. Knowledge spillover.
c. Community benefits spillover.
d. All of the above.
ANS: D PTS: 1

15. Which of the following is an example of a subsidy provided by student loans?

a. Interest is charged once the loan is made.
b. Government reimburses private lenders for defaulted loans.
c. Low-income students receive more money than higher-income students.
d. Interest rates on the loans are at least as great as the market rate of interest.
ANS: B PTS: 1

16. Pell Grants have:

a. been confined to students from low-income families.
b. discouraged students from higher-income families to establish independent status.
c. been available only to students entering comprehensive universities.
d. given larger amounts of money to students who attend relatively more expensive
institutions.

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 ANS: D PTS: 1

17. In general state tuition subsidies tend to:

a. be directly related to family income.
b. be indirectly related to family income
c. be unrelated to family income.
d. provide more benefits to students from low-income families.
ANS: A PTS: 1

18. Which are two investment decision rules?

a. future value rule and present value rule
b. present value rule and rate of return rule
c. future value rule and rate of return rule
d. discount rule and rate of return rule
ANS: B PTS: 1

19. The steps for the student decision to invest in college are:
a. List expected costs and benefits; adjust benefits and costs for time of occurrence; and
apply the 2 decision rules.
b. List expected costs and benefits; then decide if benefits are greater than costs.
c. List expected benefits and costs, then decide if rate of return on investment is greater than
the market interest rate.
d. None of the above are correct.
ANS: A PTS: 1

20. A socially justified investment in college is defined as:

a. an investment that yields a ROR greater than or equal to the social ROR.
b. a predetermined level of enrollment as defined by the federal government.
c. a level of enrollment in higher education that maximizes social benefits.
d. All of the above are correct.
ANS: A PTS: 1

21. Dawn estimates the present value of investing in a college education is $350,890 while the present
value of cost is $236,784. In this case:
a. Dawn should invest in the education.
b. Dawn should not invest in the education.
c. Dawn would be indifferent to investing in the education.
d. Dawn must first estimate the rate of return before deciding whether or not to invest in the
education.
ANS: A PTS: 1

22. James estimates his rate of return on an investment to be 6 percent. The market rate of interest is 7.5%.
We know that:
a. James should undertake the investment.
b. James should not undertake the investment.
c. James should be indifferent to the investment.
d. James must first calculate costs and benefits before deciding whether or not to invest.
ANS: B PTS: 1

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23. Suppose that you spend $3,000 for tuition, $850 on books, and sacrifice $16,000 in income during
your first year in college. The total cost of attending college for this year is:
a. $3,000.
b. $3,850.
c. $16,000.
d. $19,850.
ANS: D PTS: 1

Education
Use the following diagram to answer the following questions.
Note that HH represents lifetime earnings with a high school education and CC represents lifetime
earning with a college education.

24. Refer to Education. The earnings foregone while attending college are represented by area:
a. E.
b. T.
c. E + T.
d. B.
ANS: A PTS: 1

25. Refer to Education. Expenditures on tuition, books, and fees are represented by area:
a. E.
b. T.
c. E + T.
d. B.
ANS: B PTS: 1

26. Refer to Education. The total cost of attending college is represented by area:
a. E.
b. T.
c. E + T.
d. B.
ANS: C PTS: 1

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27. Refer to Education. If HH represents lifetime earnings with a high school education and CC represents
lifetime earning with a college education, then what area represents the benefits of a college education
that are easily valued in dollars?
a. B.
b. B + D.
c. E.
d. E + D.
ANS: A PTS: 1

28. Refer to Education. In order for the individual to invest in a college education:
a. area B must be greater than area E.
b. area B must be greater than area E + T.
c. area B + D must be greater than area E.
d. area B + D must be greater than area E + T.
ANS: B PTS: 1

29. Use the following table. What is the total lifetime earnings differential?

Age High School College

25-34 $22,000 $31,000
35-44 25,000 40,000
45-54 26,500 47,000
55-64 28,000 51,500

a. $101,000.
b. $169,000.
c. $575,000.
d. $680,000.
ANS: D PTS: 1

30. Effects of a college education that go primarily to individuals other than students or their families are
known as:
a. secondary benefits.
b. external benefits.
c. non-primary benefits.
d. indirect benefits.
ANS: B PTS: 1

31. Greg enters the labor force as a sales person for Brown and Daughters Incorporated. He spends his
days trying to get human resource managers to purchase his data base system. He hoped his degree
would provide him with a more intellectually challenging job. Greg is experiencing:
a. overeducation.
b. wastage.
c. screening.
d. overemployment.
ANS: A PTS: 1

32. Which of the following statements is correct?

a. The market for student loans would not function as well if the government did not provide
below-market interest rates.
b. Pell grants are rarely given to any individual that is not from a low-income family.

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 c. In the absence of government guarantees, the capital market would probably fail to
provide students loans for educational purposes.
d. The money appropriated by state legislatures for instructional purposes provides only a
relatively small subsidy to students.
ANS: C PTS: 1

33. Suppose private lenders are unwilling to provide loans for educational purposes. Government should:
a. provide grants.
b. provide loans at rates below the market rate of interest.
c. guarantee loans at the market rate of interest.
d. do nothing. In this case lenders are correctly perceiving risks, and government intervention
will do nothing to increase society's well-being.
ANS: C PTS: 1

34. Which of the following would be the most legitimate reason for providing subsidies to college
students?
a. There are large external costs associated with a college education.
b. Low-income individuals will not attend college without increased access to a college
education.
c. College education enhances the value of leisure to the college graduate.
d. Individuals receive increased earnings as a result of a college education.
ANS: B PTS: 1

35. If you expect to receive $1,000 one year from now and the discount rate is 0.05, what is the present
value of the future $1000?
a. $1050
b. $1000
c. $875.27
d. $952.38
ANS: D PTS: 1

36. Which are nonmonetary external benefits?

a. increased tax revenues
b. better individual health
c. higher lifetime earnings
d. community benefit spillovers
ANS: D PTS: 1

37. Which is not considered a nonmonetary external benefit?

a. knowledge spillovers
b. community benefit spillovers
c. overeducation
d. research spillovers
ANS: C PTS: 1

38. Which is not a nonmonetary benefit to the student?

a. better health
b. increased lifetime earnings
c. enhanced value of leisure
d. better decision making.

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 ANS: B PTS: 1

39. Which statement is correct?

a. Higher education is subject to the law of demand.
b. Higher education is not subject to the law of demand.
c. Increases in tuition do not cause drops in enrollment.
d. Increased state income does not increase the demand for higher education.
ANS: A PTS: 1

40. Which factors are determinants of the demand for public higher education?
a. tuition
b. income
c. price of private education
d. All of the above.
ANS: D PTS: 1

41. Which statement is true?

a. Choice of school provides a large advantage in later earnings.
b. Choice of school provides no advantage in later earnings.
c. Choice of school provides a slight advantage in later earnings only if one graduates from a
selective private Eastern institution.
d. None of the above are true.
ANS: C PTS: 1

42. Which statement is correct?

a. Engineering majors tend to have an earnings advantage over education majors.
b. Taking lots of math improves the pay-off from college.
c. The biggest pay-off is for a high grade point average.
d. All of the above are true.
ANS: D PTS: 1

43. Pell Grants are not confined to low-income families. Which is not a reason?
a. Students from middle class families are eligible for Pell Grants.
b. Grant awards tend to be larger for students attending more expensive schools.
c. The federal definition of “low income” is too high.
d. Students from high income families establish independent status in order to qualify for the
grant.
ANS: C PTS: 1

44. Which statement is correct?

a. RORs to education probably justify investment in education throughout the world.
b. Investment in education is only justified in less-developed countries.
c. Investment in education is only justified in more-developed countries.
d. Investment in tertiary education is not a productive use of society's resources worldwide.
ANS: A PTS: 1

45. If you won the lottery and were offered to receive $50,000 a year from now or an alternate sum today,
given that the interest rate is 5%, how much would you expect to receive today:
a. $47,619

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 b. $45,750
c. $43,946
d. $55,000
ANS: A PTS: 1

46. If you won the lottery and were offered to receive $25,000 a year from now, and $25,000 two years
from now, or to receive an alternate sum today, given that the interest rate is 5%, how much would you
expect to receive today:
a. $46,485
b. $45,750
c. $43,946
d. $55,000
ANS: A PTS: 1

ESSAY

1. "The interest income that could have been earned on money invested in a college education is not
relevant to the decision to attend college." Is this statement correct? Defend your answer.

ANS:
This statement is not correct. The money invested in a college education could have been invested
elsewhere. The money that could have been earned on this alternative investment is one of the
opportunity costs of attending college and should be considered when determining whether or not to
invest in a college education.

PTS: 1

2. Often, subsidies to education are justified because of the external benefits created by education. Using
this argument, do you think it would be easier to justify the subsidies going to secondary or higher
education?

ANS:
Proponents of the externality argument claim that education creates several externalities. These include
lower crime rates, increased social cohesion, and increased technological change. The chapter
discounts the effect of higher education on crime rates per se. Instead, it is the characteristics of the
individuals receiving the education that cause the correlation between lower crime rates and a college
education. Likewise, while much research is generated at the university level, this is more an offshoot
of graduate programs than the result of undergraduate programs. Finally, the benefits of social
cohesion are carried out primarily in primary and secondary education. Thus, if subsidies are to be
provided on the basis of external benefits, the majority of subsidies should be going to primary and
secondary education where the benefits of social cohesion are conferred, rather than to institutions of
higher learning.

PTS: 1

3. Evaluate the following statement. "Since subsidies to higher education do not target low-income
students, they should be eliminated. Increasing the access of these students to a higher education could
then be accomplished by making available to them government loans at the market rate of interest."

ANS:

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 It is true that subsidies to higher education are not targeted to low-income students. This does not
mean that replacing these subsidies with the aforementioned loan program would improve matters.
First, individuals may be reluctant to borrow because of the uncertainty of their future income. Second,
individuals from low-income families may have been raised in an environment that causes them to
undervalue education. If the individual is a member of a minority, this undervaluation may have been
reinforced due to past discriminatory practices. These factors mean that providing loans at the market
rate of interest may not encourage low-income individuals to attend college.

In order to overcome the first problem, loans could be income-contingent loans. The risk associated
with borrowing decreases because the obligation to repay such a loan varies with the individual's
future income.

In overcoming the second problem, it must be recognized that the decision to attend college is based
on a comparison of costs and benefits. Since the low-income individual will place too low a value on
the benefits, government will need to provide subsidies such as grants that are directed specifically
towards these students.

PTS: 1

4. Some support for public spending on higher education stems from concern about the distributional
aspects of private financing. Higher income individuals will be able to obtain more education for their
offspring than will lower income individuals. Do you believe public spending on higher education has
addressed this problem?

ANS:
There are several reasons to believe public spending has not adequately addressed this equity issue.
The student should recall that higher income individuals are able to qualify for Pell Grants, that the
size of the grant increases at the more expensive institutions where low-income students are likely to
be under-represented, and that students from high-income families may establish independent status in
order to qualify for the grant. At the state level, the structure of taxes and appropriations make it likely
that state appropriations to higher education (which are financed by state taxes) provide more in
benefits relative to taxes paid to higher income students than to lower income students.

PTS: 1

PROBLEM

1. Suppose it would cost Kathleen $45,000 in tuition and fees to attend State University. She would give
up $52,000 in earnings during her years of college attendance. If Kathleen's lifetime benefits from
attending would amount to $278,000, should she consider attending State University?

ANS:
Kathleen's opportunity cost is the $45,000 in tuition and fees plus the $52,000 in foregone earnings or
$97,000. Her benefits of attending amount to $278,000. In this case the benefits exceed cost and she
should consider the possibility of attending State University.

PTS: 1

2. Suppose Paul would pay $15,000 per year for tuition at Intelligentsia University. Books are $2,500 per
year and fees are $1,000. If Paul attends the University, he will only be able to work part time so
instead of earning $18,000 per year he will earn only $5,000. What is Paul's opportunity cost of
attending the university for four years?

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 ANS:
Paul's yearly explicit costs of attending the university are $15,000 in tuition, $2,500 for books, and
$1,000 for fees. This amounts to a total explicit cost of $18,500 per year. Paul's yearly implicit costs of
attending the university are his foregone earnings. These amount to $13,000 per year ($18,000 -
$5,000). His yearly opportunity costs are the sum of the explicit and implicit costs or $31,500 ($18,500
+ $13,000). The opportunity costs for the four years are $31,500 x 4 or $126,000.

PTS: 1

3. You are given the following information about an investment Tiffany is considering. At the current
interest rate of 6 percent, should Tiffany undertake the investment? Calculate the sum of the present
value of benefits and costs to aid you in making your decision. These benefits and costs should be
calculated to the nearest dollar.

Time (1 + i)t Benefits Costs

0 1.00 $ 0 $2,000
1 1.060 0 2,000
2 1.124 0 2,000
3 1.191 3,000 2,000
4 1.262 5,000 2,000
5 1.338 7,000 2,000
6 1.419 9,000 2,000
7 1.503 11,000 2,000
8 1.594 13,000 2,000

Time (1 + i)t Benefits P.V. Benefits Costs P.V. Costs

0 1.00 $ 0 $ 0 $2,000 $ 2,000
1 1.060 0 0 2,000 1,887
2 1.124 0 0 2,000 1,779
3 1.191 3,000 2,519 2,000 1,679
4 1.262 5,000 3,962 2,000 1,585
5 1.338 7,000 5,232 2,000 1,495
6 1.419 9,000 6,342 2,000 1,409
7 1.503 11,000 7,319 2,000 1,331
8 1.594 13,000 8,156 2,000 1,255
$33,530 $14,420

ANS:
The present value of benefits for any period is calculated as Benefits/(1 + i)t. The present value of cost
for any period is calculated as Costs/(1 + i)t. Calculations for each period are shown in the table above.
The sum of the present value of benefits is $33,530. The sum of the present value of benefits is
$14,420. Since the sum of present value of benefits exceeds the sum of the present value of costs,
Tiffany should undertake the investment.

PTS: 1

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