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College Pricing

By Chris | June 21, 2010

Ever wondered why college sticker prices are so high?  I have.  Part of the explanation is that universities price discriminate and the most palatable way to do so is to charge a high price and offer discounts based on ability and income.  But how do universities choose the price that they do?  When I was in high school I seriously considered attending Willamette University in Salem, OR.  Tuition there is currently $35,000 per year.  Over 95% of freshman receive aid.  The average need based scholarship is $15,000.

I used to think that high sticker prices were an effort by schools to signal quality.  If a school charges $50,000 prospective  students may perceive it as high quality and a great value after a $20,000 scholarship.  I figured that colleges weighed this quality signal against the real threat of scaring off prospective students with sticker shock.

However, after reading this Econometrica paper on price discrimination in education, I’ve come to an alternative explanation for high tuition.  Tuition can be thought of as a price cap on education.  Applicants differ in their income and their ability.  Because of peer effects, students are both inputs and customers.  Colleges want to admit gifted students because they make the school more valuable to other students.  However, they are willing to accept lower quality students if those students pay a higher price.  This revenue can be used to buy other higher quality students, pay for higher quality teachers, or simply increase the school’s endowment.

A school’s sticker price tells you the extent to which a school will sacrifice student quality for additional revenue.  The sticker price is inversely correlated with the quality of the lowest student.  A school with a high sticker price is advertising that it will accept really low quality students as long as they pay enough.  A school with a low sticker price is constraining itself from admitting low quality, but rich, students.  This runs contrary to the price as a signal of quality theory.  In this context, a low price actually reflects that a school is unwilling to sacrifice student quality for more money.  This explains why Ivy League schools charge tuition that is much lower than what the market would bear.

Topics: Markets, College, Economics |

10 Responses to “College Pricing”

  1. Kunal Says:
    November 6th, 2011 at 6:52 pm

    This is a really cool idea! I’m glad I stumbled across this blog.

    Theories of what to make of college costs abound, of course. Here is one of mine:

    We can think of a resume as a currency used to “purchase” jobs in the labor market. This is a nominal asset, like money, since it only matters that you have more than everyone else.

    There are a number of expensive things that people do–volunteering in Africa, taking unpaid internships, attending expensive schools–to boost their resume, presumably in the hopes of trading it in for a good job.

    Thinking of resumes as currencies can allow us to come up with a resume-to-dollar exchange rate, which reflects the amount of money one could spend to ceteris peribus boost one’s resume.

    (There are a lot of measurement problems here that I’ll gloss over. But this is the intuition.)

    You can read more about the idea at my own blog:
    http://kmthinking.blogspot.com/

    (BTW the link to the Econometrica paper doesn’t work).

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