By Chris | April 9, 2008
The president of a regional liberal arts college gave a presentation at my university today about price discrimination in higher education. Private colleges almost universally set tuition at a high rate and then offer a combination of need and merit-based scholarships to students based on their willingness to pay. In theory, poor students with rich parents are charged the most and bright students with poor parents are charged the least. By charging students different prices for the same product, universities maximize their revenue.
Colleges actually hire consultants to help them set revenue maximizing tuition levels. The consultants run econometric models to predict the price sensitivity of different categories of students to changes in tuition. For example, if you have a high GPA and excellent test scores you have more elastic demand. Or, if you visited the college and your parents are alums you are probably less price sensitive.
Financial aid offices use the econometric predictions to craft aid packages. The speaker I listened to shared data from the financial aid offers his college made and I was shocked by the results. I expected that poorer students would receive significantly more aid then richer students with similar academic credentials. I was wrong. The relationship was very weak and was actually reversed for top students. Applicants with the highest academic credentials were offered greater aid packages if they had less financial need. In other words, students with high GPA’s and test scores were offered more money if they didn’t even fill out a FAFSA (indicating no financial need).
The econometric model was telling the financial aid office that top students with a high ability to pay, had a very low willingness to pay. This counter intuitive result isn’t a fluke. It is quite possible that wealth and willingness to pay are negatively correlated. Talented students from wealthy families likely have the opportunity to pay full tuition to go to more prestigious schools. Small liberal arts schools must use price to compete. These parents and students may feel entitled to scholarship money for all the work the kids have done. Lastly, many wealthy families got that way because they have frugal tendencies. By nature, these people are more price sensitive. (In addition, the relatively smaller aid offers made to low income students may have been compensating for the federal loans and grants that these students are receiving).
When I took principles of economics, my professor used ski resorts as an example of price discrimination. Students and senior citizens are often given a discount. Students are poor and have a lower ability to pay. What about seniors? Contrary to popular belief, seniors are the wealthiest group of Americans. They just aren’t as interested in hitting the slopes. They have a high ability to pay, but a very low willingness to pay. Ski resorts and colleges have a lot in common; they are both trying to maximize revenue (costs are relatively fixed). They aren’t altruistic. It doesn’t matter if you’re poor or just frugal. If your willingness to pay is low, price discriminating institutions will cut prices to get as much revenue as they can.