Economics and Contemporary Issues

8th Edition Moomaw Solutions Manual

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 Chapter 10
Educational Reform: The Role of Incentives and Choice

What's in This Chapter and Why

This chapter deals with a persistent problem faced by the U.S. educational system; Other countries
consistently outperform the U.S. on achievement tests of mathematics and science. The chapter
takes the approach that the students must be motivated to change their behavior with regard to
academic achievement. The only way to do this is to increase the students’ marginal benefits
associated with academic achievement or lower the marginal costs of achievement.
Much space is devoted to the concept of high-stakes testing as a way to raise the marginal
benefits of academic achievement. High stakes tests that are universal, graded based on absolute
standards, internationally referenced, and analytically oriented would unite teachers and students in
a common goal: to perform well.
The most popular response to the problem of poor performance has been to require more
courses in math and science as a condition for graduation. The text explores why this will not solve
the problem.
Finally, a discussion of the economic approach to organization reveals that markets
automatically assign decision rights to those with the most useful specific knowledge,
automatically evaluate decisions, and automatically reward good decisions. The U.S. educational
system fails to meet these requirements. In fact, state departments of education are compared to 50
state owned enterprises with the inability to make market based decisions.

Instructional Objectives

After completing this chapter, your students should know:

1. U.S. students do not compare favorably to international students in the fields of math and
science.
2. Spending per pupil and student teacher ratios are not the causes of the problem of poor
performance.
3. The two rationales for public support of primary and secondary schools.
4. The student’s decision to invest more effort into academic achievement is based on marginal
benefits versus marginal costs. In order to increase achievement, marginal costs must be
lowered or marginal benefits must be increased.
5. High-stakes testing creates an incentive for students to increase achievement. There are
benefits associated with increasing achievement in this way, but there are also costs. It is not
known if benefits outweigh costs.
6. Requiring more courses as a condition for graduation is probably not an effective approach to
the problem.
7. The three principles of economic organization and that the organization of the U.S. public
school system is inconsistent with these principles.

132
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Key Terms

These terms are introduced in this chapter:

Commutative justice General knowledge

Economic approach to organization Specific knowledge
Distributive justice
High-stakes testing

Suggestions for Teaching

Students typically know that American students do not compare favorably to their international
counterparts in math and science. This has been instilled in them over the years. However, many
also believe that that more financial resources devoted to education and smaller class size could
solve the problem. It often comes as something of a surprise to them that the U.S. already spends
more per pupil than anyone else and that studies show no relationship between increased dollars
toward education and performance.
Begin this section by asking the students to list the factors that they think are important
determinants in a successful education. You may get a few answers that point toward student
benefits and costs, but you will probably get more answers like good textbooks, computers, good
teachers, teacher salaries, number of students per class, etc. List their answers on the board and
then refer to the appropriate literature to indicate that many of these factors have been shown to
have no or little impact.
Ask students to openly discuss the opportunity costs of achievement that they face and what
changes could lead them to place a higher value on academic achievement.
Compare and contrast the incentives provided under No Child Left behind and the introduced
methods of school choice. This will be particularly enlightening to students who already have an
understanding of the differences between command and control economies and market systems.

Additional References

In addition to the references in the text, instructors may wish to read or assign one or more of the
following:

1. Paul Glewwe, “Estimating the Impact of Peer Group Effects on Socioeconomic Outcomes:
Does the Distribution of Peer Group Characteristics Matter?” Economics of Education Review
16 (February 1997), pp. 39-43.
2. Gerhard Glomm, “Parental Choice of Human Capital Investment,” Journal of Development
Economics 53 (June 1997), pp. 99-114.
3. Michael Graff, “Educational Imbalance, Socio-economic Inequality, Political Freedom, and
Economic Development,” Journal of Economic Development 24 (December 1999), pp. 1-18.
4. Elizabeth M. King and Peter F. Orazem, “Evaluating Education Reforms: Four Cases in
Developing Countries,” World Bank Economic Review 13 (September 1999), pp. 409-413.
5. Elizabeth M. King, Peter F. Orazem, and Darin Wohlgemuth, “Central Mandates and Local
Incentives: The Columbian Education Voucher System,” World Bank Economic Review 13
(September 1999), pp. 467-491.
6. Gerald S. Oettinger, “Does High School Employment Affect High School Academic
Performance?” Industrial and Labor Relations Review 53 (October 1999), pp. 136-151.
134 Chapter 10/Educational Reform: The Role of Incentives and Choice

I. Outline

II. THE NATURE OF THE PROBLEM

A. International Comparisons of Math and Science Achievement
1. The Third International Mathematics and Science Study (TIMSS) is the most recent
international comparison.
2. The performance of U.S. students in math and science is among the lowest of the
countries tested.
a. US was 20 of 22 in math.
b. US was 17 of 22 in science.
c. Out of 16 countries, 14 outperformed the US in physics.
d. Out of 16 countries, 11 outperformed the US in advanced mathematics.
B. Why are U.S. Students Outperformed?
1. It is not spending per pupil.
a. The U.S. spends more per pupil than any other participating country.
b. Since 1977, spending per pupil in the US has increased by more than two-thirds,
but test scores have remained flat.
2. It is not pupil-teacher ratios.
a. Studies find that smaller class size and fewer pupils per teacher have no consistent
positive effect on achievement.
b. Eric Hanushek, a leading authority in this field, summarizes that studies of class
size, pupil-teacher ratios, teacher education, and teacher experience do not give
much support to policies aimed at expanding these resources.

III. ARGUMENTS FOR PUBLIC SUPPORT OF SCHOOLS

A. Marginal External Benefits and Efficient Levels of Education
1. When high school graduation rates are low, there may be substantial external benefits
associated with increasing rates. If so, government subsidies are justified.
2. When high school graduates rates are already high, there may be no additional external
benefits associated with even higher rates. If this is the case, there is very little
justification for government subsidies on the basis of marginal external benefits.
B. Equal Opportunity
1. Universal K-12 education is supported because it provides a better chance of equal
opportunity in an economy that is based on voluntary exchange.
2. According to Henry Simons, commutative justice is a norm for a market economy
based on voluntary exchange. Voluntary exchange means exchange of equal market
value.
3. Distributive justice is the hope that equal opportunity combined with commutative
justice moves people toward equality.

IV. THE ECONOMICS OF STUDENT ACHIEVEMENT

A. Comparing Benefits and Costs of Student Achievement
1. Costs of Individual Achievement
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a. Additional achievement requires additional time spend on learning, which has an

opportunity cost.
b. For example, the student must give up income from a job or must give up
television.
c. Individual costs vary because of differences in individual ability and alternative
opportunities.
2. Benefits of Individual Achievement
a. Perceived benefits include promotion, graduation, employment, and college
admission.
b. Individual benefits vary because of individual differences in aspirations,
knowledge, and experience.
3. Aggregate Student Achievement
a. Aggregate student achievement is subject to increasing marginal cost.
b. Aggregate student rewards from additional effort are subject to decreasing
marginal benefit.
c. The equilibrium level of student achievement occurs where the marginal cost of
achievement equals the marginal benefit of achievement.
B. Using Marginal Costs and Benefits to Explain Falling Test Scores
1. Increase in the Marginal Cost of Achievement (MCA)
a. An increase in perceived costs of academic achievement would reduce the
equilibrium level of achievement.
b. Increases in perceived costs could be due to increases in the opportunity costs of
achievement or to increases in the difficulty of learning.
2. Decrease in the Marginal Benefits of Achievement (MBA)
a. A decrease in the MBA means that the perceived rewards from achievement have
decreased resulting in reduced equilibrium levels of student achievement.
i. Less selective college admission could decrease perceived benefits.
ii. Employers placing a smaller value on school achievement may decrease
perceived benefits.
iii. Students may begin to imitate individuals whose success has not depended on
school achievement such as actors, musicians, and sports figures.
C. Ways to Increase achievement and School Performance
1. Decrease marginal cost of achievement (MCA) relative to the marginal benefit.
a. Reduce the number of hours teens can legally work. This reduces the opportunity
cost of achievement.
b. Improve the instructional environment for K-12 education.
2. Increase marginal benefit of achievement (MBA) relative to the marginal cost.
a. Make driving privileges contingent upon a minimum level of academic
achievement.

V. HIGH-STAKES TESTING
A. Increasing MBA
136 Chapter 10/Educational Reform: The Role of Incentives and Choice

1. High-stakes testing focuses on testing the achievement in the core principles of

subjects important for completing high school and for subsequent employment
opportunities and college admission.
a. This is considerably different from our current system where most students are
tested in each course and do well enough to be promoted to the next grade.
b. High-stakes tests are universal tests in that all students take them at a certain grade
level.
c. These tests use absolute performance standards imposed by external authorities.
d. The tests are internationally referenced; they should be comparable to those in
countries whose students have been outperforming U.S. students.
e. The tests should be analytically oriented, rewarding problem-solving skills more
than memorization.
2. High stakes testing must raise the stake; The test scores must have consequences.
a. Students must have the prospect of greater rewards from studying; otherwise,
significant increases in effort will be unlikely.
b. One way to raise the stakes is to use achievement test scores rather than course
grades to make grade promotion and graduation decisions.
B. The Economics of Investing in High-Stakes Testing
1. From the student’s perspective, high-stakes testing increases the benefits of academic
achievement; thus, students will move to higher levels of achievement.
2. The costs associated with high-stakes testing include the costs of developing,
implementing and grading the tests.

VI. THE ECONOMIC ORGANIZATION OF PUBLIC EDUCATION

A. Decision Making and Markets
1. Markets automatically assign decision rights to individuals with the most useful
specific knowledge, or, if cheaper or more profitable, they transfer the specific
knowledge to people who already have the decision rights.
2. Markets automatically evaluate decisions, using profitability as the performance
indicator.
3. Markets automatically reward good decisions by providing good decision makers with
more resources that can be used for consumption or investment.
B. Types of knowledge necessary for decision-making include:
a. General knowledge, which is knowledge that is easy to transmit to others.
b. Specific knowledge, which is knowledge that is difficult or costly to transmit to
others. Some forms of specific knowledge include:
i. Tacit knowledge or knowledge learned on the job through trial and error.
ii. Local knowledge is knowledge based on particular characteristics existing at a
particular time.
iii. Assembled knowledge is knowledge developed in an organization as its
members interact.
C. Decision Making and State-Owned Enterprises
1. The only enterprises that can survive significant inefficiency for long periods are
government-protected monopolies that receive government subsidies.
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2. Centrally planned state owned enterprises (SOEs) typically make decisions that are
well-informed regarding general and specific knowledge available at the center, but
they cannot be well-informed about specific knowledge that is dispersed throughout
the system.
3. When SOEs or large corporations attempt to decentralize decision-making, they must
use scarce resources to use and develop an evaluation system.
4. SOEs and large corporations must develop their own procedures–rewards– that induce
employees to make the appropriate decisions.
D. Decision Making and Public Schools
1. A state department of education (SDE) is, in effect, the central planning office of a
state-owned enterprise.
2. An SDE is apt to be politicized and be responsive to parents and special interest
groups. Special interest groups include the teachers’ unions, environmental
organizations, and other organizations promoting ideological and religious ends.
3. In situations where specific information is important, markets exemplify three
important organizing principles
a. Assignment of decision rights
i. Politicians and bureaucrats place two burdens on effective decision making in
K-12 education.
(i) They have decision rights about curriculum, teacher qualifications, and
textbook selection that restrict the choices of principals and teachers.
(ii) Many objectives other than academic ones are placed on teachers and
principals. Some examples are promoting community service, providing
sex education, developing a drug-free America, and winning athletic
championships.
b. Evaluate the profitability of decisions
i. Teachers with tenure are difficult to fire or to reprimand.
ii. Performance is irrelevant in salary determination.
c. Reward profitable decisions
i. Unions insist that all teachers are rewarded the same; this does not encourage
excellence.
ii. Governments interfere with their professional judgement and impose
numerous mandates that require them to spend time on activities other than
academics.
d. SOEs and the organization of schools violate the three organizing principles.

VII. GOVERNMENT POLICY

A. Stay the Course: Spend more per pupil
1. Increases in real spending over time have been large.
2. Achievement results from more spending are minimal.
3. The public cost of charter schools per pupil is less than for regular public school
a. Parents are more satisfied with charter schools.
b. There is improved performance on tests at charter schools.
B. Improve or Else: No Child Left Behind
138 Chapter 10/Educational Reform: The Role of Incentives and Choice

1. Assumes that policy makers can establish goals, require testing, and develop pedagogy
for schools to increase achievement.
2. Provides additional resources for failing schools but threatens closure if there is no
improvement.
3. Provides parents the option and resources to change schools.
4. Education Commission of the States (ECS)
a. A top-down, 10-year plan to improve public education by:
i. Increasing school achievement.
ii. Ensuring proficiency of all students in reading and mathematics by 2013-14.
iii. Guaranteeing a qualified teaching staff.
iv. High stakes testing on schools and teachers to induce them to get students to
achieve more.
(i) The emphasis is on core academic achievement.
(ii) There exist incentives to manipulate test scores to improve the outlook of a
school or teacher.
(iii) Teachers are motivated to teach to the test.
C. Consumer Choice
1. There is increasing use of school vouchers, private scholarship funds, charter schools,
and home schooling.
a. Most of the parents of students in private schools are “very satisfied” with the
school and their academic standards, compared to less than half of those who
attend assigned public schools.
b. Higher income provides better choice among public schools because it provides
greater choice among residences.
c. Studies show that choice improves performance.
i. The school must offer a product parents demand.
ii. Competition among schools leads to a variety of educational programs suited
to parent demands.
2. Competition and choice could be introduced into K-12 education.
a. A system of vouchers could be used.
b. To succeed, schools would have to provide students the educational experience
their parents demand.
c. Principals would have to evaluate teachers based on their success with students.
d. Some economists have long argued that competition within the education system
will lead to existing schools improving their performance.
e. There is a positive response when there is a direct link between performance and
rewards.

Answers to Review Questions

1. What does the chapter identify as the problem or problems with U.S. public schools?

Evidence seems fairly clear that the U.S. school system is not the best in the world. In the
 Instructor's Manual 139

Third International Mathematics and Science Study (TIMSS), typical U.S. students participated
with typical students from various other countries in comparisons of mathematics and science
achievement. The study concluded that the performance of U.S. students in mathematics and
science was among the lowest of the participating nations. For example, the United States was
20th of 22 in math achievement and 17th of 22 in science achievement. Out of 16 countries, 14
outperformed the U.S. in physics and 11 outperformed the U.S. in advanced mathematics.

Why does the U.S. perform so poorly in international comparisons? It is not because of low
spending levels. The U.S. spends more per pupil than any country except for Switzerland. In
fact, spending per pupil in the U.S. has risen by 90% since 1970, but achievement scores have
remained flat. The conclusion seems to be that we are spending more money on education, but
are seeing no results.

2. The chapter discusses two possible rationales for government support of education. What
are they? Evaluate them.

The first rationale in support of government support of education contends that there may be
significant marginal external benefits associated with secondary education. As in the case of
higher education, when the student fails to recognize the external benefits created by their
schooling, they fail to invest or engage in enough educational activity to be optimal for society.
In order to induce students to engage in more educational activity, the government subsidizes,
or in the case of public secondary education, completely provides the education.
External benefits may not be as compelling an argument for government provision of
secondary education as it is for government subsidization of higher education. In the case of
low high school graduation rates, there may, in fact, be substantial external benefits associated
with increasing the graduation rate. However, in a situation where graduation rates are already
quite high (as in the U.S.), there may be no additional external benefits associated with
increasing the rate. Refer to the diagram below.

Price per Unit

MSB

D=MPB<MSB

MSC

D=MPB=MSB

E1 E2 Quantity of
Education
per Time Period

Note that at E1, a relatively high rate of education, there ceases to be any external benefits
associated with higher rates of education. In the example above, the equilibrium level of
140 Chapter 10/Educational Reform: The Role of Incentives and Choice

education is at E2. Notice that at E2, there are no external benefits, marginal private benefits
(MPB) equal marginal social benefits (MSB). In addition, this is the optimal level because
MSB = MSC. In the society demonstrated by the above graph, there is little justification for
subsidizing education based on the external benefits argument.

The more likely explanation for why the U.S. continues to fund public primary and secondary
education has to do with equality, or the ideal of equal opportunity. In a society where the
economy is organized around voluntary exchange, people need to have enough knowledge to
make appropriate decisions that will, hopefully, increase their well-being. According to Henry
Simons, “Such justice connotes exchange of equal values, as measured objectively by
organized markets.” Simons called justice emerging from voluntary exchange commutative
justice. Simons also believed that distributive justice is an important goal of society. People are
given different initial amounts of wealth and ability, and this inequality, according to Simons,
is overwhelmingly a problem of investment in human capital.

3. The model of academic achievement presented in this chapter suggests that high school
and college students choose a level of academic achievement that is a compromise
between achievement and other goals. For what other goals have you sacrificed a small
amount of academic achievement? What changes would lead you to place a higher value
on academic achievement?

A discussion of the opportunity cost of academic achievement will differ for each student. The
individual student faces different alternatives to the use of their time, and thus faces different
opportunity costs. What follows is a non-exhaustive list of some goals that might cause high
school students to sacrifice small amounts of academic achievement: athletic achievement,
popularity in the sense that “smart kids” aren’t “cool,” popularity in the sense that spending
time with friends takes time away from studying, romantic involvements, extra-curricular
school activities, part-time jobs, and pressure to “help out” at home.

Again, students will have different answers for this question, but some common ones might
include the following. A greater certainty of receiving college scholarships would lead to a
higher value on academic achievement. A greater certainty of being accepted into the college
of my choice would lead to a higher value on academic achievement. A greater certainty of
placement into a job of my choice would lead to a higher value on academic achievement. A
greater certainty of receiving a higher income due to academic achievement would give it a
higher value.

4. What are the four characteristics of high-stakes testing, and why is each characteristic important?

High-stakes testing requires students to take achievement tests in order to apply for grade
promotion, high school graduation, college admission, and employment. Literally, students
become required to perform academically before they can realize important goals. It creates a
situation where academic achievement becomes very important; itincreases the stakes. The four
primary characteristics of high-stakes testing are as follows.

(1) The tests are universal. All students must take the tests at a certain grade level.
Achievement tests, such as these, would concentrate on the core principles of a subject. The
courses taken prior to the test should provide the students a clear understanding of what they
must know in order to succeed on the achievement tests. High expectations would be
established for all students. Some argue that the current practice of allowing students to “water
down” their education denies them the equal opportunity to succeed in the workplace or in
 Instructor's Manual 141

higher education in the future.

(2) The tests use absolute performance standards, not relative performance standards such as
“curves.” The absolute grading scale would be externally imposed. In other words, state or
federal authorities would determine passing levels. Teachers would not be allowed to judge
students relative to their classmates or to go easy on students because they “tried hard.”
Students and teachers will have a common objective: to score above the passing mark on the
test.

(3) The tests are internationally referenced. U.S. students find themselves in competition with
workers from other countries. This is a trend that is only going to continue to grow. The
external standards on these exams should be equal to the standards set for students in the
countries that have been outperforming the U.S.

(4) The tests are analytically oriented, rewarding problem solving skills more than
memorization. The workforce of the future will need to be proficient in problem solving. Under
high-stakes testing, students would develop the ability to use core principles to work in real-life
problem solving.

5. Suppose high-stakes testing results in greater achievement. If so, does that mean that it is
the preferred education reform?

As with any economic decision, it is inappropriate to look only at the benefits of the decision.
If high-stakes testing is successful then it will likely result in significant benefits in the form of
higher earnings. Several studies seem to indicate that greater academic achievement will lead
to increased post-high school earnings. For example, John Bishop finds that an increase of one
standard deviation in General Intellectual Achievement test scores is associated with a 3-4%
increase in earnings. Furthermore, the authors of the text believe that the earnings differentials
shown in such studies are actually understated.
It seems clear that there would be some benefits associated with high-stakes testing.
However, there would also be some costs. Significant costs would be associated with
producing the new tests, creating new courses and texts, changing teaching techniques, and
producing more effective teachers. In addition, there are costs associated with creating the
standards and grading the tests. Unfortunately we do not know the size of the costs relative to
the benefits associated with high-stakes testing; consequently, it is too early to know if it is the
preferred form of educational reform.

6. Some states require students to take additional mathematics and science courses. Will
this lead to U.S. students performing at the same level as students in other countries?
Why or why not?

Requiring more courses in science and math has been a popular response to the problem of low
academic achievement in the U.S. Apparently, politicians think it will improve student
performance. Economists, however, are skeptical. Some economists do not believe that these
requirements will be effective unless students perceive a change in the marginal benefits or the
marginal costs of achievement. Increasing requirements raises the marginal costs of
achievement and gives students an incentive to look for low cost alternatives such as “watered
down” courses. Teachers tend to help the students by using curve-based grades. In order to
produce achievement, marginal costs must be lowered and/or marginal benefits must be
increased. According to these economists, high-stakes testing increases the marginal benefits of
success and produces the desired results.
142 Chapter 10/Educational Reform: The Role of Incentives and Choice

There are also economists who question the cost effectiveness of requiring more courses. They
are really raising the issue of whether government should be involved in education to the extent
that they are telling teachers and principals what courses must be offered. Does the government
really understand the process of education so much better than teachers and principals to justify
the extent of their involvement? These economists argue that the public should work together
with teachers and principals to determine the appropriate minimum level of achievement, and
then give the schools the freedom to determine how they are going to achieve this.

7. Which of the following is specific knowledge and which is general knowledge and why?
a. The distance to Washington, D.C.
b. The ability to ride a bicycle.
c. The U.S. Bill of Rights
d. The ability to read a map.
e. The way to win at poker.
f. The plot of Romeo and Juliet.

a. The distance to Washington, D.C. is general knowledge because its measurement can
easily be transmitted from one person to another.

b. The ability to ride a bicycle is specific knowledge. It is almost impossible to tell someone
how to ride a bike. Individuals simply must learn how to do this activity by trial and error,
making it a type of tacit knowledge.

c. The U.S. Bill of Rights is general knowledge. If this information must be transmitted, it is
as simple as handing a written copy of the U.S. Bill of Rights to another person.

d. The ability to read a map is specific knowledge to a certain degree. It is true that almost
anyone can read a map, but it is a lot easier for me to read a map that is referencing an area
that I am familiar with. I have some local knowledge about the area, and that makes the
map easier for me to read.

e. The way to win at poker is certainly specific knowledge. The best tactic for winning
probably depends on the other players at the table. Thus winning at poker requires
assembled knowledge, knowledge that is assembled as members of a group interact.

f. The plot of Romeo and Juliet is essentially general knowledge. Two kids fall in love. Their
families hate each other. Thinking Juliet is dead, Romeo kills himself. Upon awakening to
find Romeo dead, Juliet kill herself. See how easy that was?

8. This chapter suggests that giving parents more control over their children's education
would be to the children's advantage. Do you agree? If not, why not? If so, does this imply
that home schooling is a method of education superior to education in a school system?
Explain.

Positive educational outcomes for school children are surely desirable by parents and everyone
else involved. However, it is not clear if more parental control through privatization of
education would result in desired outcomes. The answer to this question could come from a
comparative study of education models around the world. It should be noted that there are
many public school systems (in developing countries!) that produce far better outcomes than
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U.S. schools. This disproves that privatization and control would lead to better outcomes.
Given the labor force participation in the United States, home schooling, even if desirable, is
not practical for the majority of people.

9. Specific knowledge of profitable opportunities is scattered throughout the economy or

throughout a business firm. How does a market economy make use of specific
information? How does a business firm managed from the top down make use of specific
information?

The beauty of the market organization is that it results in an efficient use of information by
assigning decision rights to people who have specific information. As a result, specific
information does not have to be transferred. Because different bits of specific information are
often widely distributed, their existence implies the importance of decentralized decision
making, which may require that decision makers be evaluated and provided with incentives. A
market organization provides this evaluation and motivation at low cost.

From the business perspective, suppose a retail company is headquartered in South Carolina,
but has markets across the southern half of the Untied States. Clearly, the CEO of this
company, who likely lives in South Carolina, does not have specific knowledge about the
markets in Oklahoma City, OK or Gainesville, TX. He/She probably does have access to a
plethora of general information such as population, per capita income, land area, average
annual retail sales, etc.

Consider some of the specific information that this CEO is missing. The CEO does not
understand the attitudes of consumers in the area. He/She doesn’t necessarily know what kinds
of products they want and want kinds of adverting works. To a certain extent, this requires
knowledge acquired through trial and error. Our text calls it tacit knowledge.

Our CEO also doesn’t fully understand the workforce and how they will react to various rules
and requirements of employment. It will take a manager, working among the employees, to
learn through personal interaction the best approaches to take with respect to employee
management. Our text calls this assembled knowledge.

Most large businesses handle this problem by assigning decision rights to someone who does
have specific knowledge. Local managers, for instance, are given the task of making most of
the everyday decisions involved with running their store. If the store does not do well, central
decision-makers often blame the failure on decisions made by the local manager (whether right
or wrong). Of course, the opposite is often true, as well. Managers may be given the credit (and
rewards) for stores that are profitable.

10. What are the three elements of an economic approach to organization?

The three elements of an economic approach to organization are as follows. The market
automatically assigns decision rights to individuals with the most useful specific knowledge,
or, if cheaper or more profitable, they transfer the specific knowledge to people who already
have the decision rights. In either case, decisions are made by people who have the relevant
specific knowledge. Second, markets automatically evaluate decisions, using profitability as
the performance measure. Third, markets automatically, reward good decisions by providing
good decision makers with more resources that can be used for consumption or investment.

11. Think of your introductory economics class as an organization. Suppose the professor’s
144 Chapter 10/Educational Reform: The Role of Incentives and Choice

objective is to have the highest average score on a standardized test of any introductory
economics class of about the same size and composed of similar students. Who has the
relevant decision rights in the class? What are the roles of evaluation and rewards in
attempting to achieve the objective?

Clearly, the professor has some level of authority in the class. He/She certainly has the right to
set an achievable goal for the class. Unfortunately for the professor, the relevant decision rights
belong to the students. The students must decide it is worthwhile for them to achieve this goal.
Is there anything in it for them? Frankly, there are a lot of students who hope to pass their
economics class, but nothing more. How will the professor lead those students to greater levels
of achievement?

If the professor wants to outperform all of the other intro classes in a true sense, there must be
some objective, external standard of evaluation for the test. For example, the professor might
have an unusually low achieving class, but since he/she grades on a curve, the grades assigned
will actually appear unusually high. Thus a high “average” has been set, but has the class really
outperformed all the other classes?

The heart of the matter is that the professor must somehow cause the students to adjust their
perceived marginal benefits and/or marginal costs of achievement. One way to do this, of
course, is to raise the stakes–especially for those students who are only interested in passing the
course. One possibility is to set the standard very high and with extreme consequences. For
example, if the professor warned the class that 80% would be considered passing, and anything
below 80% would be considered failing, the result is likely to be a significant number of
students pushing themselves to score an 80% as opposed to the more common 60%. (It might
also lead to organized rebellion!) The point is there is no reward associated with 60%. Rewards
are not realized until 80%.

12. Compare and contrast the approach to education reform implicit in No Child Left
Behind and in charter schools.

No Child Left behind is a top-down policy aimed to improve U.S. education. It assumes that
central planners or policy makers can establish goals, require testing, and develop pedagogy for
schools to achieve better results. It provides some additional resources for failing schools and
ultimately presents them with the stark alternative of improvement or closure.

Choice, however, is becoming an important part of the policy dialogue, which includes
vouchers, charter schools, choice of district public schools, and home schooling. A charter
school gets public funding on a per-pupil basis and is exempt from many of the regulations that
public school administrators must deal with. With its emphasis on parental choice, the charter
school approach is one that relies on market-like mechanisms to improve children’s
educational experience.

Charter schools and other forms of choice in public education provide greater local
accountability and flexibility. Principles and teachers can take advantage of their specific
information. They are provided a more direct link between their performance and rewards
because they must respond to parents and potential competition.

Like any other organization, managers of a school system must decide who makes decisions,
how the decisions are evaluated, and how they are rewarded. State departments of education
often control decision rights that may more appropriately be assigned to principals and teachers
 Instructor's Manual 145

at local schools. By centralizing decision rights, the state ignores much specific information
held by principals and teachers. As a political organization, the public education system
responds to politicians and bureaucrats, and to that extent it is less responsive to students and
parents. The centralization of decisions made at the state level and in large local school districts
combined with teachers’ unions makes it difficult to evaluate local decision makers––teachers
and principals––and to reward their performance.