The bright side of higher college tuition

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Article Highlights

  • Much has been made recently of the rising cost of attending a four-year college.

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  • But all of this attention typically focuses on colleges’ “sticker prices”

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  • In reality, only the relatively wealthy pay the high sticker prices.

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  • Paying for college is the ultimate example of price discrimination - and is a good thing for students.

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Much has been made recently of the rising cost of attending a four-year college. House Speaker John Boehner has decried the fact that “during the 1980s, the cost of attending college rose more than three times as fast as the typical family income,” and that “[t]his trend of rapidly-increasing college costs continued unfettered through the 1990s.” President Obama has threatened colleges and universities with funding cuts unless they clamp down on tuition increases.

But all of this attention typically focuses on colleges’ “sticker prices” or posted tuition rates. In reality, only the relatively wealthy pay the high sticker prices. The prices that most students pay are lowered – often quite dramatically – by financial aid. In fact, much of the increase in sticker prices merely reflects an improvement in the ability of schools to price discriminate, or charge different prices to different students for the same educational services. This is a positive development, as price discrimination makes higher education affordable for a larger number of individuals. Policies aimed at controlling increases in tuition will hamper the ability of schools to price discriminate, harming lower-income students by reducing their access to college.

As the graph below shows, sticker prices at private nonprofit four-year institutions rose by around 60 percent in inflation-adjusted terms between the 1993-94 and 2013-14 academic years. However the actual price – net of financial aid – paid by the average student rose by only around 30 percent over the same period.

While the grants included in the graph come from both the schools and the government, a number of studies have suggested that most government aid is captured by educational institutions rather than students. If these studies are correct, then increases in government aid are likely to be offset by reductions in institutional aid, resulting in roughly the same net prices for students. That is, the divergence between sticker prices and net prices primarily reflects an increase in price discrimination rather than an increase in government aid.

Sticker price increases have been even more dramatic at the top schools, but these schools have also been most ambitious with their financial aid policies. For example, at Stanford University, parents making under six figures are not expected to pay any tuition at all.

Many would argue that it seems deeply unfair to charge different people different prices for the same goods or services. For example, in 2000, Amazon had to apologize when it was caught charging different prices for the same goods based on consumers’ browsing histories. States have price gouging laws that prevent stores from increasing prices during high demand. And people frequently get irritated about the arbitrariness of airline and concert ticket prices.

But price discrimination can be a good thing for consumers. For example, airlines stay in business by charging high prices to business travelers and low prices to tourists and other pleasure travelers. If they were forced to charge the same price to both sets of consumers, the price of an airline ticket would wind up somewhere between the tourist price and the business traveler price. That would make business travelers better off, but it would make tourists worse off. It would also make travel less affordable for many people.

Paying for college is the ultimate example of price discrimination. Through the financial aid application process, colleges learn exactly how much each student can afford to pay and tailor their tuition accordingly. And as colleges have gotten better at this process, they have been asking the relatively wealthy to pay higher sticker prices so that the less fortunate can receive increased financial aid.

Price discrimination does lead to higher profits for the seller. At a nonprofit college or university, all of these profits must be re-invested in the school itself. Some have objected that these profits are wasted on frivolous expenses like palm trees and climbing walls. But the reality is that most of it goes towards attracting talented professors and providing important student services. Even if some of the profit is poorly spent, it is still the case that higher tuition makes generous financial aid possible. And generous financial aid is crucial for making higher education accessible to talented individuals who might not otherwise be able to afford it.

Higher education certainly needs reform. While post-secondary education is becoming increasingly necessary to enter the middle class, the number of new college graduates has plateaued in recent years. But misguided attempts to stop the rise in sticker prices are likely to backfire, reducing the generosity of schools’ financial aid and making college less accessible to lower-income students.

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