Price and Output Decisions for Firms Under Conditions of Perfect Competition, Monopolistic Competition, and Oligopoly

The price and output decisions for profit-maximizing firms under conditions of perfect competition, monopolistic competition, and oligopoly vary according to each market structure. All firms maximize profits at the price and output level where marginal revenue (MR) = marginal cost (MC), but under different market structures, firms have different demand curves and therefore different revenue structures. Depending on the market structure, profit-maximizing firms make different price and output decisions, and these decisions have different social implications.


Perfectly Competitive Market Structure:

In a perfectly competitive market, firms can't control prices because goods have perfect substitutes, there are a very large number of sellers (and buyers), and firms can easily enter and exit the market. Instead, prices are determined collectively by market supply and demand. The demand curve, then, is perfectly elastic and average revenue (AR) = MR = price (P). Although firms in perfectly competitive markets can’t control prices, they can control their level of output, which they set at the profit-maximizing level of MR = MC. Because P is equal to MR, P is also equal to MC at the profit-maximizing level. As a result, perfectly competitive markets are characterized by pure allocative efficiency – the cost to society for producing another unit is exactly equal to what society pays for that unit. Resources are allocated to allow the maximum possible net benefit, and consumers can get more goods at lower prices than under any other market structure.


Monopolistically Competitive Market Structure:


In monopolistic competition, firms’ still maximize profits where MR = MC. Unlike a perfectly competitive market, however, firms can control prices under conditions of monopolistic competition because of product differentiation. The amount that consumers are willing to pay depends on their degree of preference for different products. These preferences are rarely totally influential – if the price of one producer’s good rises high enough, consumers will switch to a cheaper alternative because of the substitution effect and the income effect. As a result, the demand curve is downward sloping. P > MR, because in order to sell additional units, firm owners must lower the prices of every single unit they sell. If MR = MC and P > MR at the profit-maximizing level, then P > MC. In other words, society has to pay more for goods than goods cost firms to produce. Still, this does not necessarily mean that imperfectly competitive markets are inefficient. After all, if society did not value product differentiation, it wouldn’t pay higher prices for goods with cheaper substitutes.


Oligopoly Market Structure:

Oligopolies are comprised of a few firms, each with a very large share of the market. Cost structures are still the same and firms still maximize profits where MR = MC, but because there are fewer competitors, firms in oligopolies can set P even higher above MC at the profit-maximizing level. Output is lower and market prices are higher than in monopolistic competition and perfect competition. What is unique about firms in oligopolies is that they tend not to raise or lower prices, because at higher prices demand is elastic and at lower prices demand is inelastic – raising or lowering prices would result in revenue losses. As a result, MC can increase or decrease without affecting the profit-maximizing price and output level, and smaller cost savings and increases are not passed to consumers. There are still costs to society, but the market price does not reflect the relative scarcity or abundance of input resources.

Oligopolies and the Kinked Demand Curve Theory

Demand curves in oligopolies are kinked because of price “stickiness” – the phenomenon of prices staying the same – in oligopolistic markets. An oligopoly is comprised of a few mutually interdependent firms, each with a very large share of the market. If a firm raised its prices, all of its customers would turn to its competitors. If a firm lowered its prices, other firms would be forced to follow suit, and all firms would lose revenue. Even when production costs increase, firms in oligopolies resist raising prices. The social implications of price “stickiness” as explained by the kinked demand curve theory are that small cost savings and increases are not passed on to consumers.

Firms in an oligopoly tend to not raise prices because they face a very elastic demand curve above the market price. If a firm were to even slightly increase its prices, it would lose a huge portion of the market to its competitors. Below the market price, demand is inelastic. If a firm lowered its prices, it would not pick up a significant portion of the market because the firms’ mutually interdependent competitors would also have to lower their prices. Firms could gain a small amount in market share initially, but any market gains would be more than offset by what firms would lose in revenue per unit sold. The “kink” in the demand curve is formed by the elastic portion of the demand curve above the market price and the inelastic portion of the demand curve below the market price.

To understand the rationale of the kinked demand curve, it helps to think about its graph. A firm’s demand curve is also its average revenue (AR) curve. Each AR curve has its own marginal revenue (MR) curve, which falls in twice as steep as the AR curve. The “kinked” demand curve for firms in an oligopoly can be looked at as two different demand curves – the elastic demand curve above the kink and the inelastic demand curve below the kink – each with its own MR curve. The different MR curves create a discontinuity, the effect being a vertical portion of the MR curve at the profit-maximizing price and output level. As a result, the MR/marginal cost (MC) relationship is not defined at one specific point, instead, the MC cost curve can fall anywhere in between the vertical gap between the first MR curve and the second MR curve. Smaller increases and decreases in production costs do not change the market price, output level, or the MR/MC relationship. In any other market structure, a change in MC would move along a non-vertical MR curve, which would change the profit-maximizing price/quantity relationship.

Because MC can increase or decrease without altering the profit-maximizing price and output level, smaller cost savings and increases are not passed on to the consumer. There are still costs to society, but the market price does not reflect the relative scarcity or abundance of input resources. When prices in oligopolies do increase, it is because production costs keep rising and firms can no longer afford to keep prices the same forever – and all firms dramatically increase prices at once. At that point, the quantity demanded decreases, output falls, and the demand curve forms a kink around the new profit-maximizing price and output level. Much larger costs (and savings), then, are passed to consumers.

The Short-Run Supply Curve for an Individual Firm

In the short run, firms face two types of costs: fixed costs (FC), incurred by the firm at any level of output, and variable costs (VC), which vary with the level of output. Added together, FC and VC equal total costs (TC). Marginal costs (MC) are the costs of producing an additional unit, measured by the change in TC divided by the change in output. MC decrease initially, then increase with the level of output in accordance with the law of diminishing returns, which holds that additional output decreases as more of one input is added and other inputs are held constant. Because adding inputs costs money, increasing output becomes increasingly costly.

Say someone wants to open a donut factory. First he needs to purchase a building and all the necessary equipment – the FC. To begin production, he has to buy donut materials, such as sugar, icing, etc., and hire a worker to make the donuts – the VC. Initially, MC are low. The owner already has the building and equipment, and pays a small additional amount for a worker and materials. As production rises, the worker can produce donuts efficiently for 8 hours per day. To further increase production, the owner may decide to hire more workers. At first, two workers work more efficiently together than one worker by himself, because two workers can divide the donut-making process into specialized tasks. Eventually, however, if the owner hires too many workers, they get in each others’ way because they all have to share the same equipment and space. Albeit paid the same as the first two workers, each additional worker produces less efficiently. As a result, the costs of producing additional donuts – the MC – increase.

If one graphed the number of donuts produced and the MC of producing the donuts, with the quantity of donuts on the x-axis and the MC of production on the y-axis, the graph would look like a supply curve – the only difference being that a supply curve would have price (P) instead of MC. The profit-maximizing donut factory owner is only willing to produce donuts at a level of output where P is equal to or greater than MC. Therefore, by substituting P for MC on the graph, one can get a good idea of the donut firm’s supply curve. Regardless of the market structure, all firms maximize profits at the output level where MC equals marginal revenue (MR) – the additional revenue a firm receives from selling an additional unit.

At the donut factory, MC decrease and profits rise after adding the second worker, motivating the owner to hire more workers. On adding too many workers, however, output starts to slow and MC exceed MR; to reverse that trend and maximize profits, the firm cuts back on its donut output by reducing VC, i.e., the number of workers. By definition, average revenue (AR) is the P per unit. In a perfectly competitive market, AR and MR are the same because P is constant – firms are too small and too numerous for any one to affect the market price. Because P is always the same, incremental revenue is equal to per unit revenue. If P = AR and AR = MR, then P = MR. And if firms maximize profits where MR = MC, then in perfectly competitive markets, firms maximize profits where MC = P. As a result, the short-run supply curve for an individual profit-maximizing firm in a perfectly competitive market is exactly the same as the MC curve.

In the short run, profit-maximizing firms still produce when costs exceed revenues, as long as average variable costs (AVC) are lower than P at the profit-maximizing output level. Because firms suffer losses equal to FC if they produce no output, then as long as P is higher than a firm’s minimum AVC, the firm is better off producing because it can cover its VC and use remaining revenues to cover some FC. If P falls below the minimum AVC, however, it is more profitable not to produce, because the firm cannot cover VC at any output level. As a result, the short-run supply curve for an individual profit-maximizing firm in a perfectly competitive market is the increasing part of its short-run MC curve starting above the minimum AVC.

Utility and Consumption

The notion of “utility,” or satisfaction, is generally used to explain how consumers choose among different consumption options. The law of diminishing marginal utility holds that the amount of additional satisfaction consumers get from consuming each additional unit of a good or service decreases with each unit consumed. Because consumers get less and less satisfaction from additional units, they become less and less willing to pay the market price for each additional unit; therefore, consumers buy more when prices fall and less when prices rise. This inverse relationship explains why the demand curve is negatively sloped.

Understanding the law of diminishing marginal utility allows one to understand the equimarginal principle, which holds that maximum satisfaction or utility occurs when the marginal utility per last dollar spent on a good or service is exactly the same as the marginal utility per last dollar spent on any other good or service. If, for example, the consumption of an additional unit of good A yielded more marginal utility per dollar than the consumption of an additional unit of other goods, to maximize satisfaction individuals should spend less money on the other goods and consume more of good A until the marginal utility per dollar of good A falls to the same marginal utility per dollar of the other goods. Conversely, if good B yielded less marginal utility per dollar than the common level, consumers would buy less of good B and more of other goods until the marginal utility per last dollar of good B rose to that of the common level.

Another way of thinking about satisfaction involves indifference curves, which show how consumers react to different combinations of products. On a graph of indifference curves, one good appears on the x axis and the other good appears on the y axis. At any point along a given curve, consumers are equally satisfied with the combination of products – each point brings the same level of utility. Superimposing an income curve over a set of indifference curves shows all the different combinations of the two goods and/or services a consumer can purchase with a fixed budget. Consumers maximize their satisfaction when their income curve barely runs tangent to the highest indifference curve. If the price of good Y falls and the price of good X stays constant, the point of tangency changes, and satisfaction increases as consumers can buy more of good Y and reach higher indifference curves. If the price of good Y rises, satisfaction decreases as consumers are forced to move to lower indifference curves. Moreover, the diminishing marginal rate of substitution explains that, all else constant, the rate at which an individual must give up one good increases in order to obtain additional units of the other good. Good Y must therefore become relatively cheaper in order for individuals to be persuaded to take a little more of good Y in exchange for less of good X.

Indifference curves and marginal utility theory both show that to maximize total satisfaction, a consumer’s ratio of marginal utility to price must be the same for all goods and services. Consumers therefore demand more when prices fall and less when prices rise; as a result, the demand curve is negatively sloped. Conceptually, this phenomenon can be explained two different ways. If the price falls, the substitution effect holds that consumers tend to increase consumption because the good has become relatively cheaper than similar goods and consumers will get more satisfaction per dollar at the lower price. The income effect explains that when prices fall and consumers’ income stays the same, real income increases. In effect, consumers are wealthier, so they can buy a greater amount of the cheaper good and, for that matter, other goods. (Conversely, if the price rises, the substitution effect holds that consumers buy less, because the good has become relatively more expensive compared to similar goods. The income effect holds that consumers consume less because they are, in real terms, less wealthy.)

Basic Principles of Supply and Demand

A change in the quantity demanded of a good or service is caused by a change in the price of the good or service. When supply decreases and the price rises, consumers’ willingness to purchase the good or service decreases. When supply increases and the price falls, consumers’ willingness to purchase the good or service increases. When the quantity demanded of a good or service changes, the set of prices and quantities of the original demand schedule remains constant. The demand curve does not shift, instead, changes in quantity demanded are depicted by a movement along the demand curve, from one price-quantity pair on the curve to a new price-quantity pair on the curve.

By contrast, a change in demand occurs when consumers’ willingness to purchase a good or service increases or decreases because of some factor other than a price change, such as a change in consumers’ income levels, a change in the size of the population, changes in the prices and availability of substitute goods, changes in the prices and availability of complementary goods, changes in individual, cultural, and social tastes, or other special influences. If, for example, everyone suddenly wanted an iPhone because they saw Sean Connery using one in a movie, the shift in cultural taste would trigger an increase in demand for iPhones and a decrease in demand for Blackberrys, despite the fact that the prices of iPhones and Blackberrys hadn’t changed. When demand changes, the set of prices and quantities changes from the set of prices and quantities of the original demand schedule. Changes in demand are depicted by a shift of the demand curve from its original position – to the right if demand increases and to the left if demand decreases.

A change in the quantity supplied occurs when the price of the good or service changes. As demand for a good or service increases and the price rises, producers tend to supply more of that good or service, because they profit from utilizing more input factors and increasing output. If demand decreases and the price of the good or service falls, producers supply less of the good or service, because utilizing more inputs to supply a larger quantity is no longer profitable. When the quantity supplied of a good or service changes, the set of prices and quantities of the original supply schedule remains constant. Changes in quantity supplied are depicted by a movement along the supply curve, from one price-quantity pair on the curve to a new price-quantity pair on the curve.

By contrast, a change in supply occurs when producers’ willingness to supply a good or service changes because of factors other than the price of the good or service, such as technology, input prices, sellers’ expectations, taxes, subsidies, the number of sellers, or other special influences. Producers are primarily concerned with production costs: when they increase, producers tend to supply less; when they decrease, producers tend to supply more. If, for example, the cost of electricity goes up, producers will supply less because production costs have increased. If the government lowers the minimum wage, producers will supply more because production costs have decreased. When supply changes, the set of prices and quantities changes from the set of prices and quantities of the original supply schedule. Changes in supply are depicted by a shift of the supply curve – to the right if supply increases and to the left if supply decreases.

Economists Should Think About Divorcing Themselves From the GDP

Economists are considered to be an elite breed of professionals – intelligent, sophisticated, and well-educated. When I think of an economist, I envision an old man with white hair, wearing a turtleneck and smoking a pipe, lecturing to a group of enamored subjects at a cocktail party about the future of the world. Although I can’t speak for everyone, I’d be willing to bet that many people harbor a similar mental image. If this is the stereotype, if economists are supposed to be so clever, then why are they always wrong?

Thirty years ago, economists were preaching that Japan would have the largest economy in the world by the 21st century. During the 1990s, many believed that the stock market would rise to 25,000 by the year 2010. And in the 2000s, economists said we would never again experience another major recession because of advances made in the theory of monetary policy. Although the reasons why economists make mistakes are undoubtedly numerous and complicated, many of their inaccuracies may stem from the fact that the GDP, the main economic indicator used by economists all over the world, does not accurately measure economic growth.

For starters, the GDP does not measure the economic value of unpaid labor. Housework, unpaid internships, and volunteer work do not factor into the GDP, yet it cannot be disputed that a society would suffer if it lost these services. As the saying goes, “when a man marries his maid, GDP goes down.” Moreover, women who leave the workforce to raise children cause the GDP to fall, but having babies should not be considered a drag on economic growth. If anything, babies stimulate economic growth by creating a need for healthcare, consumption, education, etc. Eventually, babies grow up, become part of the labor force, and add value to society as factors of production.

The GDP also doesn’t consider pollution or other costs of economic growth. When the resources of the wetlands or forests are destroyed by economic activity, the GDP views these events favorably. China’s GDP, for example, is growing at a rate of 10% per year, but what are the economic costs of the pollution that growth creates? Considering that industries also get paid for cleaning up their mess, economic activity affects the GDP twice. An accurate economic indicator would subtract the negative effects of pollution from the positive effects of production. The GDP also fails to account for global warming, nuclear waste storage, and other long-term consequences of economic growth.

Perhaps the biggest problem with the GDP as an economic indicator is that it doesn’t distinguish between different types of spending. For example, crime, natural disasters, and defense expenditures all cause GDP to go up. The events of Hurricane Katrina and the Vietnam War, as measured by the GDP, were hugely beneficial to the economy. Moreover, the GDP fails to distinguish between efficient and inefficient expenditures. Infrastructure projects that facilitate growth and provide long-lasting benefits to society are viewed in the same light as money spent on wasteful projects and programs.

Another limit of the GDP is that it fails to take income distribution into account. A rise in GDP that increases the wage gap between the rich and the poor directly benefits just a small segment of the population (the rich), whereas if a greater percentage of the increase in wages that came from an increase in GDP went to the poor, the majority of society would benefit. It can be argued, of course, that what benefits the rich benefits everyone, as rich people are far more likely to save money, which leads to higher rates of national investment and future growth. Still, many experts believe that the GDP is a poor indicator because it doesn’t measure income distribution.

The point is that economists should not rely so heavily on the GDP. As globalization proceeds and countries continue to develop, accurate economic predictions will become increasingly necessary and relevant. Economists would do well to look beyond their traditional yardsticks and either develop new indicators or conduct more thorough analyses of the countries, events, and trends that they study.

Teachers’ Unions and the Decline of the United States Economy

Part 1: A History of Underachievement

For nearly a half century, the American public school system has been the laughing stock of the world community. Today, high school graduates in the United States have far fewer math, science, and language literacy skills than their counterparts in other developed nations, not to mention their counterparts from previous generations. The U.S. economy has suffered as a result: GDP growth has slowed, jobs have been outsourced or filled by foreign firms, and the overall health of the economy has become increasingly unstable. Many economists believe that the United States will never be able to regain the prestige it held in the twentieth century. Much of the blame for this decline can be traced to teachers’ unions. In the United States, teachers’ unions make it extremely difficult for public administrators to fire teachers who do not perform. This coercion serves two purposes: it discourages competition (after all, why would anyone work hard or try to excel if they knew they could not be fired?) and it ensures that teachers’ wages remain low, effectively keeping qualified, incentive-driven individuals out of the education system. The cumulative machinations of teachers’ unions over previous decades are evidenced in the high unemployment rate, ballooning trade deficit, and ever more vulnerable national security. If the education system is not righted soon, the United States will confront a future that even Malthus could never have predicted.

Since the 1960s, professional educators have tried to instruct students using numerous methods, including New Math, open classrooms, and Whole Language; notwithstanding these educational fads, the quality of the teacher has always been the single greatest factor in determining how students perform. In fact, researchers have proven that the quality of the teacher matters more than class size, teaching method, technology, or curriculum. Even the quality of the school, statistically speaking, does not matter as much as the actual person who teaches the students. After all, large high schools can have as many as six different teachers teaching the same course, and even great institutions can have poor teachers.

As important as good, qualified teachers are, it is extremely difficult to determine a teacher’s ability by reviewing his or her resume or certifications. Teaching can be taught to a certain extent, but for the most part, the ability to teach is innate. Some individuals are naturally competent to control rambunctious children, lead by example, and inspire original thoughts and ideas. Others, no matter how many certifications they acquire or how prestigious the college or university they attended, simply do not have the interpersonal characteristics or leadership qualities necessary to be effective teachers.

Education systems would benefit from incentive strategies that would compensate teachers whose efforts regularly produced high-performing students; such compensation would not only motivate teachers, it would create a competitive environment that would encourage teachers to constantly be thinking of innovative ways to teach their students. Out of these free market principles of supply and demand, new and improved methods of instruction would emerge. Such an approach underlies the recent focus of U.S. President Barack Obama and Secretary of Education Arne Duncan on teacher accountability and their institution of a new 4.3 billion dollar program, “Race to the Top,” where states have to devise new ways to identify great teachers, determine what makes them great, and produce more of them in order to win the “race” and the many millions in federal prize money.

“Race to the Top” could be the first step towards true reform of an educational system that has been a national embarrassment for decades. Since as far back as the 1960s, teachers’ unions, such as the National Education Association and the American Federation of Teachers, have worsened the education system protecting poor teachers at the expense of students. During his 23-year tenure, Albert Shanker, the former head of the National Education Association, pushed for better conditions for teachers regardless of talent or effort. Today, after only two or three years with a particular educational institution, most teachers are given lifetime tenure, making it nearly impossible to fire them. In fact, 99 percent of all teachers are rated “satisfactory” by their school systems, because experience has shown that firing teachers often leads to costly and fruitless court battles with local unions. The fact that the Obama Administration has confronted them is significant, not only because teachers unions are major contributors to the Democratic Party, but because unions have grown even stronger in recent years.

Because teachers have not been held accountable for their performance, education has become an attractive profession for underachieving college students. A recent review by McKinsey and Company showed that in the 2000s, most elementary and high school teachers were recruited from the bottom third of college graduates. Other experts believe that teacher-education is the main problem. According to an article in The Chronicle for Higher Education, “teacher-education programs at many colleges have been labeled as underachievers and were allowed to slide by with poor grades … for too long, the colleges of education have been cash cows – with big classes and little quality control.” Either way, the fact that educational institutions are attracting poor students and producing undereducated teachers is unfortunate, considering that children who have weak teachers in consecutive years are far less likely to succeed. Even more tragic is the fact that the worst teachers are often assigned to teach the neediest students – minority children in inner-city schools.

In addition to accountability, compensation is another issue. The average teacher’s salary is dismally low when compared to the salaries of other professionals. Because teachers’ unions do not permit that bad teachers be fired, schools often try to improve student performance by wasting money on programs that are usually ineffective. Cities, as a result, are not able to devote as much of their public school system budgets to teacher salaries (much less to increasing compensation for demonstrably good teachers). In a survey conducted by the Bureau of Labor Statistics, median annual wages of kindergarten, elementary, middle, and secondary school teachers ranged from $47,000 to $51,180 in 2008. The lowest 10 percent earned between $30,970 to $34,280, and in the 2005-2006 school year, teachers who had recently graduated from college earned an average of $33,227. By contrast, surgeons – the highest wage earners – average $181,000 per year; other highly paid professionals include lawyers (who earn $110,590 per year), political scientists ($104,130 per year), and astronomers ($101,300 per year). Moreover, teaching used to be one of the few jobs not denied to women and minorities. As society has progressed and become more inclusive, however, talented women and minorities have left the teaching profession to pursue higher-paying careers.


Part 2: Effects on Education

As America’s teachers as a whole continue to get worse, the country’s elementary schools and high schools continue to produce poorly educated students. Today, the average college freshman has to take remedial courses for subjects that past generations mastered during high school. According to a report issued by the Educational Testing Service, Americans barely reach the international literacy average set by advanced democracies. Several years ago, the United States ranked 12th in a literacy test given to a survey of adults aged 16 to 65. Graduates in recent decades were the primary cause of this fall; Americans who graduated high school in the 1960s ranked third, those schooled in the 1970s ranked 7th, and those schooled in the 1990s ranked 14th.

Although bad teachers have caused an across-the-board decline in education standards, students’ math skills have especially suffered. According to the National Assessment of Educational Progress (NAEP) long-term trends (LTT) assessment data, U.S. high school students have fallen far behind their peers in other advanced industrial countries. In 2003, according to the Organization for Economic Cooperation and Development’s (OECD) Program for International Student Assessment (PISA), average U.S. test scores were well below test scores of other developed countries. By 2006, the gap had increased. While the top 10 percent of students throughout the developed world who took the assessment scored 615 or above, the top 10 percent in the United States scored an average of only 593. These scores do not bode well for the U.S. economy, for as President Barack Obama said in his speech to a joint session of Congress in February 2009, “Countries that out-teach us today will out-compete us tomorrow.”

Considering that improving the math scores of U.S. high school students has been the subject of policy debates for the last thirty years, it is puzzling how the country’s high schools have gotten away with undereducating their students. The situation is further complicated by conflicting indicators. For instance, since 1990, the average number of math credits a high school graduate completes has increased by 20 percent. Moreover, high schools claim that they are performing better, as indicated by an eighteen percent increase since 1990 in the average math GPA of high school students. A significant disconnect exists, therefore, between the increase in the number of math courses taken, higher student GPAs, and actual skills acquired. Either the courses have gotten easier over the years or the performance metrics have become less rigorous or both.

U.S. elementary and high schools are also failing to teach U.S. students basic science skills. The United States now ranks below thirteen other countries – including Japan, Germany, and South Korea – in the percentage of twenty-four year olds with a college degree in science subjects. Twenty-five years ago, the United States ranked third. Once a world contender in science and technology, the United States’ position has eroded as our public schools have failed to teach these subjects to the next generation. Considering that twenty-eight percent of teachers who teach at least one science class between the 7th and 12th grades do not have a major or even a minor in science and that sixty percent of all science teachers do not have a major or minor in science, the decline in science proficiency among U.S. students should not come as a shock. Once again, the main issue is one of compensation – for the few individuals who do end up getting degrees in science, there are simply too many other lucrative opportunities.

U.S. students who do not gain science skills in high school are obviously ill-prepared for college-level science courses. According to the Third International Mathematics and Science Study, by the time American students reach their senior year in high school, they rank below their counterparts in seventeen other countries in science literacy. In physics, U.S. high school seniors scored dead last among 16 countries tested. The National Science Teachers Association reports that just twenty-six percent of high school graduates scored high enough on the ACT science test to have a good chance of completing a first-year college science course. Not surprisingly, fewer and fewer U.S. students are becoming science and engineering majors, despite the fact that demand for these skills continues to increase.


Part 3: Economic Impact

In most countries, and the United States is no exception, education and training are cause-and-effect related to economic performance; in fact, economists generally consider labor quality to be among the most important contributors to a robust economy. In a recent article about education, Eric Hanushek, an economist for the Hoover Institution, wrote that, “The simple answers in the discussion of economic implications of education are that educational quality measured by cognitive skills … has a strong and robust influence on economic growth.” Skills acquired through education are essential to economic development. Time spent in school, however, will not lead to greater math and science proficiency unless children receive a quality education from well-qualified, effective teachers. While resources are important, the key barrier to quality education is a lack of incentives for both students and school personnel to improve learning outcomes. Improving the quality of schools in the United States will require profound structural changes to create these incentives.

As American students have become less skilled in science and mathematics, the economically critical engineering, information technology, and manufacturing sectors have stopped growing and are now in decline. For most of the second half of the 20th century, strong demand in the United States for science, technology, engineering, and mathematics (STEM) professionals fueled significant economic growth in these sectors. During that time, STEM professionals not only met labor demands for these sectors, they generated demand through the innovation of new products and processes. Since the mid-90s, however, STEM professionals have accounted for a declining share of total employment in the United States. In 2005, the National Academy of Sciences, the National Academy of Engineering, and the Institute of Medicine issued a joint report in which they found that “the scientific and technical building blocks of our economic leadership are eroding at a time when many other nations are gathering strength.” As globalization continues to spread, markets continue to arise, and emerging countries continue to develop, demand for new engineering and technology products will be met not by the United States but by our foreign competitors.

The decline of the science, technology, engineering, and mathematics sectors in the United States has also led to a deep trade deficit that has cost the country millions of jobs, lowered wages, increased national dependency on foreign countries, and destabilized the domestic economy. Since 1998, the U.S. has lost nearly 2.5 million manufacturing jobs that were either outsourced overseas or filled by foreign firms. Data from the U.S. Department of Commerce’s Bureau of Economic Analysis on imports indicates that payments for foreign computer and information services nearly doubled between 2001 and 2005. Imported research, development, and testing services tripled. As the trade deficit continued to increase during the 2000s, many economists worried that new surges of imports would further damage other domestic industries. So far, foreign lenders have provided the funds the United States needs to finance its deficit, but many economists believe that if foreign countries stop lending to the United States, the value of the dollar will plummet and interest rates will rise. As a result, credit will tighten, business investment will decrease, and the foreign goods we are now so dependent on will become much more expensive.

The effect of lost jobs on the U.S. economy can be seen by the slowdown in year-to-year GDP growth, which has been occurring ever since the 1970s. The technology boom jumpstarted the U.S. economy during the 1990s, and much of the growth during the first decade of the 21st century was driven by the financials sector and consumer spending. After the economy collapsed in September 2008, however, Jeff Immelt, the CEO of General Electric, stressed the need for the U.S. to expand its manufacturing base, claiming that the United States has outsourced too many jobs and that consumer spending and the financials sector would not be able to sustain the economy in the future. Indeed, since 2008 the manufacturing base has not been expanded, and economic forecasts for the next several years remain grim. Fifty percent of unemployed Americans have been out of work for more than six months, the U.S. would have to generate 400,000 jobs each month for three years in order to replace the number of jobs lost during the recession, and the unemployment rate is likely to remain close to six percent by 2015, even as the economy stabilizes. Furthermore, of the remaining U.S. jobs requiring PhDs in science and technology, 38 percent are now filled by foreigners, many of whom send money home to their families and therefore out of the U.S. economy.

In addition to widening the trade deficit, costing the United States jobs, and slowing economic growth, the decline in the number of U.S. students with science, technology, engineering, and mathematics degrees is threatening our national security. According to a report released by DARPA, the research agency for the Pentagon, the issue is of “national importance” and “affects our capacity to maintain a technological lead in critical skills and disciplines” on the international stage. The report claims that there is a downward trend in computer science degrees, despite the importance of these degrees in the Internet Age. As a result, our national security is at risk. DARPA writes:

"Our systems are becoming more complex, requiring more people with the
software engineering talent to manage and maintain them. Finding the right people with increasingly specialized talent is becoming more difficult and will continue to add risk to a wide range of DoD systems that include software development."

In an effort to reverse this trend, DARPA is accepting proposals for programs and initiatives to get American students into STEM careers, especially in computer science. The fact that the government is asking the public for help is worrisome, because it indicates that is has no solution to the problem. Considering that the poor quality of U.S. education today can be directly linked to the prevalence of poor teachers and that teachers’ unions that protect and promote poor teachers are gaining, not losing, power and influence, discrete, individual initiatives will more than likely fall short and the situation will only be remedied when the United States completely overhauls its educational system.


Part 4: Conclusion

The decline of the manufacturing, engineering, and computer science sectors, the trade deficit, and the increased vulnerability of our national security represent major problems for the United States. The country is losing the ability to sustain itself, and consequently, is becoming increasingly dependent on foreign countries. Millions of jobs lost during the Great Recession do not appear likely to be regained. Terrorism and the growth of other countries’ militaries pose ever-greater threats. If these trends continue, lost jobs and lower wages will lead to ever-lower standards of living coupled with ever-larger indebtedness, which in turn will lead to foreign governments demanding higher rates of return on U.S. Treasuries. Higher interest rates will result in even less consumption and business investment, which of course translates into further declines in economic growth. Potential terrorist attacks or wars as a result of a weakened national defense will harm tourism and lead to capital destruction (GDP would go up as capital goods are rebuilt, but the rise would not indicate true economic health). These trends and their respective problems can be directly traced to teachers’ unions. By discouraging competition and keeping wages low, teachers’ unions have kept qualified individuals out of the public education system and ensured that underperforming, undereducated rubes could keep their jobs. While up until now it has been students who have suffered most from the poor quality of American education, in the future, the entire nation will be sacrificed.