Tuesday, February 24, 2009

Variable Costs in Higher Education

by Daniel Bennett

Inside Higher Ed published a story today in which University of Florida asked tenured faculty member Florence Babb to increase her teaching load to 3 courses per year to help the university (which pays her an annual salary of nearly $100k) get through the current downturn. Babb, who currently teaches 2 class a semester and serves as coordinator of a women's study center, refuses to accept increased responsibility and has brought her faculty union to help battle the request. So much for asking workers to increase productivity.

Firms make production decisions by finding the optimal output level by setting the marginal cost (MC) equal to the marginal revenue (MR). MR is derived from a revenue function, in which total revenues (TR) are equal to the product of price and quantity {TR = P*Q}. MC is derived from a cost function, in which total costs (TC) are equal to the total fixed costs (FC) plus the product of the average variable cost (VC) and quantity {TC = FC + (AVC*Q)}. By setting MC equal to MR, the optimal output is achieved when P = AVC.

In general, fixed costs are comprised of capital and variable costs of labor.

This is not necessarily the case for the higher education industry due to the presence of academic tenure that guarantees faculty members lifetime employment. Assuming that the average new faculty member begins at the age of 30 and plans to retire at 65, this supposed labor input has essentially become a fixed cost due to the compensation the university has guaranteed the faculty member for the next 35 years. It has absolutely no resale value and the school can't call the local faculty repair man to come fix it when it becomes unproductive (like it can for other capital investments). Considering that faculty members comprise a majority of a college's labor force, their being a FC substantially impairs a school's ability to adjust its VC's during different stages of the business cycle.

In most industries, a firm will reduce its VC's during downturns in the economy and this is what we have seen with the large number of layoffs in the private sector. In doing so, firms retain their best employees and ask them to be more productive for the sustainability of the organization. The higher education industry (also faced with the reality of an economic downturn) has a harder time reducing its VC's, partly due to faculty tenure contracts and unions. Essentially, faculty members, which comprise a majority of their labor force, are FC's for colleges. Is it any wonder why colleges increasingly hire part-time adjuncts to teach?

The UF story mentioned above illustrates that faculty members are more of a FC than a VC and provides ammunition for the coalition to eliminate academic tenure and/or continue to staff classrooms with adjunct instructors. Colleges and other industries (e.g. auto, government) are not immune from business cycles and should be permitted to reduce costs when times are tough. Faculty unions attempt to remove this capability without providing much in the way of concessions. Job security is a benefit (not an entitlement) and should come as a trade-off for wages and other compensation (retirement, health care, time off, etc). Faculty should be presented with a menu of benefits to choose from that includes tenure. Those who choose job security should receive a reduction in pay or other benefits commensurate to a net present value calculation.

This would help to alleviate the problem associated with labor being a high FC by allowing them to more readily adjust VC's during different phases of the business cycle. This in turn would help control tuition. After all, schools should be be producing where P = AVC. If colleges can't significantly reduce their AVC's because labor is more of a FC, then it would follow that schools will either have to raise prices or close up shop.

4 comments:

right-wing prof said...

"Those who choose job security should receive a reduction in pay or other benefits commensurate to a net present value calculation"

Uh Mr. Bennett, this is already the case. It is basic economics that eliminating tenure, ceteris paribus, would force faculty salaries to rise. Believe me if my job security was taken away I would demand higher pay or, more likely, have chosen an entirely different line of work.

right-wing prof said...
This comment has been removed by the author.
capeman said...

Absolutely right, R-W prof. In the natural sciences, which are the academic field I know best, people who take academic postdocs (post-Ph.D. work in preparation for an academic university career) earn half or less what a fresh Ph.D. going into industry or government makes. The pay differential persists as you go up the ladder.

For full professors in the sciences, the pay differential is often much more than a factor of two.

If universities want to abolish tenure -- a very bad idea, in my opinion -- they better be prepared to pay industry salaries and other financial inducements.

maxheadroom said...

President Barack Obama laid out an agenda Tuesday that would do just about everything but cure cancer.

Actually, he promised to try that too.

In the span of his 52-minute speech, Obama pledged to deliver health care to every American, cap carbon pollution, retool the auto industry, overhaul the regulatory system, and claim the highest proportion of college graduates in the world by 2020. And that’s only a partial list.

Obama’s first appearance before a joint session of Congress made clear that the worst economic crisis in 70 years won’t shrink his ambitions.

The one thing he didn’t explain – how to pay for it, what is surely trillions in new spending in coming years.

“None of this will come without cost, nor will it be easy,” Obama said in the address. “But this is America. We don’t do what’s easy. We do what is necessary to move this country forward.”

“Everyone in this chamber – Democrats and Republicans – will have to sacrifice some worthy priorities for which there are no dollars. And that includes me,” Obama said. “But that does not mean we can afford to ignore our long-term challenges.”

Obama then gave a history lesson about trying times when, he said, the “nation responded with bold action and big ideas.” The Civil War led to a rail system that fostered commerce. The Industrial Revolution spawned the public education system. World War II produced the GI Bill, which created “the largest middle-class in history,” he said.

What will the worst economic crisis since World War II bring? This is Obama’s wish-list from Tuesday’s speech:

— National health care coverage within the year.

— Seek a “cure for cancer in our time.”

— Reestablish America as producing the highest proportion of college graduates in the world by 2020.

— Lay “thousands of miles of power lines,” and construct wind turbines and solar panels.

— Expand mass transit.

— Reform the regulatory system

— Pass legislation that places a market-based cap on carbon pollution

— Commit to the goal of a “re-tooled, re-imagined auto industry.”

— Invest in electronic health records and new technology to reduce medical errors.

— Create new incentives for teacher performance

— Expand commitments to charter schools

— Sign legislation on national service authored by Sens. Edward Kennedy and Orrin Hatch.

— End direct payments to “large agribusinesses that don’t need them.”

— Eliminate no bid contracts in Iraq.

— “Root out waste, fraud and abuse in our Medicare program.”

— Jettison tax breaks for corporations that ship jobs overseas.

— No new taxes – “not one single dime” – for families that earn less than $250,000 a year.

— Begin debate on overhauling Social Security while creating “tax-free universal savings account for all Americans.”

— Increase the number of soldiers and Marines – and raise their pay and benefits.

— Encourage parental responsibility.

Sen. Charles Grassley (R-Iowa) liked that last promise – in part because it’s free.

“Concentrate on what Obama said about parental involvement in kids education,” Grassley wrote on Twitter shortly after the speech. “I'm going to help him. (Without) spending one penny that will do good.”