Archive for August 20th, 2012

August 20, 2012

Reasons for surging college costs, including ‘massive price discrimination’

by Grace

Richard Vedder offers a list of reasons for rapidly rising college costs.  But first he opines on two “rival explanations” for this problem.

University presidents and some economists (e.g., David Feldman and Robert Archibald) often cite the Baumol Effect (named after a Princeton economist), arguing that higher education is a service industry where it is inherently difficult to raise productivity by substituting machines for humans. Teaching is like theater: it takes as many actors today to produce King Lear as it did when Shakespeare wrote it 400 years ago. While there is some truth to the argument, in reality technology does allow a single teacher to reach ever bigger audiences (using everything from microphones to streaming video). Moreover, in reality a majority of college costs today are not for instruction–the number of administrators, broadly defined, often exceeds the number of faculty.

The second explanation comes from former Education Secretary Bill Bennett: rapidly expanding federal student financial assistance programs have pushed up college prices, so the gains from student aid accrue less to students than to the colleges themselves, financing an academic arms race. Recent studies (by Stephanie Rieg Cellini and Claudia Goldin, Andrew Gillen, and Nicholas Turner) support the Bennett Hypothesis. Student aid has fueled the demand for higher education. In the market economy, increased demand for a product made by one company (say the iPhone) quickly spurs competition (other smart phones), so prices do not rise. That fails to happen in higher education, as many providers restrict supply to enhance prestige. Harvard has an Admissions Committee, McDonald’s does not.

12 key “expressions that help explain the college cost explosion”.

  1. Third party payments
  2. Lack of information
  3. Lack of profit motive
  4. Lack of well-defined goals
  5. Resource rigidities
  6. Barriers to entry
  7. Politicized control
  8. Price discrimination
  9. Rent seeking policies
  10. Cross-subsidization
  11. Murky ownership
  12. Governance problems

Vedder comes at this problem from a preference for market driven solutions.  This is  usually my perspective as well, although I haven’t fully reviewed all of Vedder’s assertions.

One of his arguments is that applying price discrimination as a way of achieving diversity inflates costs.

Eighth, universities try to charge what the traffic will bear, engaging in massive price discrimination, favoring some students (poorer ones, extremely bright ones, those with preferred skin colors) more than others (more affluent, less bright kids, those whose skin color is less desirable).

This makes sense.  Charging what the market can bear doesn’t always lead to competitive pricing, especially when the reasons for price discrimination lead to a lower quality product.  While the goals may be worthy, offering massive financial aid in the form of loans to students ill-prepared to succeed in college is a bad idea.  It adds to cost inflation while leaving many college dropouts burdened with debt that limits their future economic opportunities.  Price discrimination combined with some other factors from this list like lack of information and barriers to entry adds to the problem of runaway college costs.

A different perspective on college price discrimination from Kevin Drum at Mother Jones
I’ve highlighted the salient point of my disagreement, which is that the current system is ushering too many unqualified students into college.

Nonetheless, there are some classic cases where price discrimination works. College tuition is one: if you’re rich, you pay full price. If you’re middle class, you get grants and loans. If you’re poor, maybe you get a full ride. In theory, everyone who’s qualified goes to college, and the college itself extracts the maximum possible revenue from its students….

In the case of college, price discrimination is possible because, in fact, colleges can ask for a copy of your 1040 before they ring up the sale. And the end result is widely viewed as fair, since most of us think that poor but qualified students should go to college….

Related:  ‘there has been a severe contraction in the quality of higher education’ (Cost of College)

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