1. Egan Cornachione
12/5/2013
IntermediateMicroeconomicTheory
Policy Brief: The Federal Direct Loan Program
The price tag for higher education is high and steadily increasing. The College Board
(2013) reports that the average price for tuition, fees, room and board at a four-year private
nonprofit college is $40,917 per year (up 14% over 5 years) and $18,391 per year at a public
four-year college (up 20% over 5 years). In order to make a college education available to more
students, the government offers low-interest student loans. Although federal student loans have
been available for many years, the current program, called the William D. Ford Federal Direct
Loan Program (FDLP), was recently implemented in 2010 (Branigin 2010). With the program,
students can take out federal loans at a considerably lower interest rate than those of private
loans- the other option available to students. With the passage of this new program, the
government no longer guarantees private loans. The FDLP offers several options for loans:
unsubsidized loans, subsidized loans, PLUS loans for graduate students and parents, and
consolidation loans. Subsidized loans are those in which the interest is deferred by the
government while the student is still in college. These loans and unsubsidized loans are most
common to undergraduate students and will be the focus of this report. With the high cost of
college, federal loans allow more consumers into the market for a college education than would
be able to with only private loans; however the benefits do not outweigh the costs of the
program. I recommend that the government take steps to withdraw from the loan market for
higher education. The text will examine how the program affects the average consumer of
higher education, looking at their world with and without the program, and will cite several

2. examples to show how the Federal Direct Loan Program may be adversely impacting higher
education.
The following is an analysis of how the program works, in theory, allowing students into
the market for a college education. It will specifically look at the demand for four-year private
colleges. Figure 1 models a budget constraint for the average consumer’s demand for a four-year
private college education and a composite good, X. The average student must pay a price per
unit of education P over four years for tuition, fees, room and board after school aid. Some
amount of P will be paid for by the consumer taking out student loans. Without the FDLP,
students would have to take out the same amount of money in a private loan and pay interest at a
rate of about 7.8%, on average (Consumer Financial Protection Bureau 2012). This would
effectively cause the price per unit of a college education to increase to P1, or the price paid
before the FDLP. With the FDLP, students can take out loans at an interest rate of only 3.86%
and if they choose to take a subsidized loan, the consumer can have interest subsidized while
they are in school, both of which decrease the price compared to P1 (Federal Student Aid 2013;
College Board 2012). The price per unit of education under the FDLP is labeled P2.
Figure 1 shows the budget constraint of a consumer with income M and a price of the
composite good of $1/unit. It is also assumed that the consumer faces a minimum amount of
education possible to be in the market for a four-year private college education (i.e., one needs at
least 127 credits to obtain a degree). This amount is labeled as E(o). All bundles with an
education level less than E(o) are unattainable. The budget constraint of a consumer without the
program is given by the green line in the model. The blue line represents the budget constraint
of the same consumer with the effective price reduction of a four-year private college education
under the program. The maximum amount of the composite good X available to the consumer

3. does not change under the program, but the maximum amount of education attainable to the
consumer with this level of income increases from M/P1 to M/P2, as P1>P2.
To examine how the introduction of the program can allow some consumers to enter the
market who would previously be unable to do so, an indifference curve (IC 1) for a consumer is
drawn through the maximum amount of consumption of X but does not include any other
attainable point on the first budget constraint. Thus, without the program, this consumer’s utility
maximizing bundle is at point A, spending all their money on the composite good. With the
introduction of the program, higher levels of utility are now available to this consumer on the
M/P1 M/P2E(o) E
X
IC 1
IC 2
M
X(o)
Figure 1: Budget Constraint for Average Consumer of Four-Year Private College Education
A
B
= BC before FDLP
= BC withFDLP

4. new budget constraint. The highest attainable indifference curve for this consumer is labeled IC
2, which is shown to pass through the minimum amount of education attainable, E(o). Thus,
their new utility maximizing bundle is at point B, with education E(o) and consumption of the
composite good X(o). Thus, the FDLP allows some consumers to obtain a four-year private
college education who previously would be unable to enter the market for one.
As should be expected based on the model, college enrollment rates have steadily
increased over the past twenty years, from 1990 to 2010, thanks in part to the federal student
loan program (College Board 2013). However, after the introduction of the new program in
2010, enrollment rates have actually begun to drop. Between 2011 and 2012, enrollment
decreased by 0.3%, and between 2012 and 2013, rates dropped by 2.3% (National Student
Clearinghouse Research Center 2013). At the same time, the average amount of federal aid has
shown a slight decrease and tuition at colleges has increased. The total student loan debt among
working Americans is over $1 trillion, and the default rate on those loans is up to 9.1% (Stiglitz
2013; Anderson 2010). Although student loans increase enrollment and allow more students into
the market, the debt burden on students is becoming too large.
Making sense of the increases in tuition, Wolfram (2005) studied the link between
student loans and increasing college tuition prices and found that increasing federal student loans
causes an increase in tuition prices. He suggests a 12 year government “phase out” from the loan
market that would lower tuition prices and lead to either competition in the private loan market,
increased private scholarships, or human capital contracts. Following up on Wolfram’s research,
McClusky (2011) examined the taxpayer burden of the federal student loan programs. Adjusted
for inflation, taxpayers have steadily increased their funding of the student loan program between
1985 and 2010, meaning, in other words, that taxpayer costs for higher education are increasing

5. from an already high level. Although the benefits of higher education are tricky to determine,
McClusky finds that the costs to taxpayers outweigh the benefits of student loans. The loan-
tuition relationship causes a cycle- as federal loans rise, tuition rises, and as a result, loans rise
again. As discussed in a New York Times series called “The Great Divide,” the results of this
cycle have led to the increasing $1.2 trillion student debt and have harmed other sectors of the
American economy, such as the housing industry and the job market (Stiglitz 2013). The
prospect of facing this high student debt burden has turned many students who were previously
considering college away from it because the cost is too great (Greenstone and Looney 2013).
The Federal Direct Loan Program provides the opportunity for students to attend college
that would be unable to do so, given current conditions, without the program. Unfortunately, the
many negative side effects of this program are causing it to fail to make college an affordable
opportunity for all. If, as Wolfram (2005) suggested, the government withdraws from the loan
market, tuition would decrease, which would cause a decrease in the price of education, similar
to that shown in Figure 1 from P1 to P2. This would have a similar effect, allowing more
students back into the market for a college education. Private scholarships and other forms of
private or institutional aid would compete and fill the role that the federal loan market held. The
Federal Direct Loan Program is having a negative effect on the higher education market, and I
strongly recommend it be terminated.

6. Works Cited:
Anderson, Fred. “Default Rates for Cohort Years 2006-2010.” Washington, DC: United States
Department of Education, 2013. Accessed November 23, 2013 http://www.ifap.ed.gov/
eannouncements/082013DefaultRatesforCohortYears20062010.html
Branigin, William. “Obama signs higher education measure into law.” Washington Post,March 30,
2010. Accessed November 23, 2013. http://voices.washingtonpost.com/44/2010/03/
obama-signs-higher-education-m.html?hpid=topnews
College Board. “Trends in Higher Education.” The College Board Advocacy and Policy Center. Accessed
November 23, 2013. http://trends.collegeboard.org/
Consumer Financial Protection Bureau. “Private Student Loans.” Washington, DC: United States
Department of Education, 2012.
Federal Student Aid. “Types of Aid: Loans.” United States Department of Education. Accessed
November 3, 2013. http://studentaid.ed.gov/types/loans/interest-rates#what-are-the-interest-
rates-of-federal-student-loans
Greenstone, Michael; and Looney, Adam. “Rising Student Debt Burdens: Factors Behind the
Phenomenon.” Washington, DC: The Brookings Institution, 2013.
McClusky, Neal. “CATO Institute Policy Analysis no. 686: How Much Ivory Does This Tower Need?
What We Spend on, and Get from, Higher Education.” Washington, DC: CATO Institute, 2011.
National Student Clearinghouse Research Center. Current Term Enrollment Estimates: Spring 2013.
Herndon, VA: National Student Clearinghouse Research Center,2013. Accessed November 23,
2013. http://nscresearchcenter.org/currenttermenrollmentestimate-spring2013/#more-852

7. Stiglitz, Joseph E. “Student Debt and the Crushing of the American Dream.” New York Times,May 12,
2013. Accessed November 23,2013. http://opinionator.blogs.nytimes.com/2013/05/12
/student-debt-and-the-crushing-of-the-american-dream/?ref=studentloans&_r=0
Wolfram, Gary. “CATO Institute Policy Analysis no. 531: Making College More Expensive: The
Unintended Consequences of FederalTuition Aid.”a Washington, DC: CATO Institute, 2005.