Saturday, January 20, 2007

Why does college cost so much?

There is currently a proposal in Congress to cut the interest rate of student loans. Similar proposals to subsidize the expense of college recur frequently at the federal, state, and even local levels. Such proposals are inspired by the high and ever-increasing cost of college. Yet it is rarely asked why the price of a college education is both so high and constantly increasing.

When the question is asked, college administrators sometimes say that costs are increasing. But this fails to provide any information about where the money is going. Another common response is that state aid to higher education has decreased. Taxpayers would do well to be skeptical of such claims. But even if this were true, it still doesn't explain why the total cost, including the cost to taxpayers, is so high and increasing.

There is significant taxpayer money spent on education, there are more and more private scholarships, and more and more alumni donations to universities. At the same time, the price of college just keeps increasing. How can this be?

Actually, it shouldn't be surprising at all. When government subsidizes something, demand increases, and when demand increases, prices rise. Colleges that conscientiously held down prices would be forfeiting government money. Contrary to the self-serving image that colleges paint, they are actually particularly egregious in milking their customers.

Like most any institution that sells goods or services, colleges want to charge as much as possible for the services that they provide. In principle, there's nothing wrong with this, since consumers want to pay as little as possible and the two must freely agree to some price for a transaction to occur. However, the situation of college education is different from typical transactions.

Since different consumers value the same good differently, the maximum amount that they will pay for it varies from person to person. Theoretically, an institution could maximize its profit by charging a different price to each consumer. In practice, most institutions don't have the information needed to do this, and consumers would revolt if they tried.

However, this is exactly what colleges are doing. Colleges quote everyone the same high list price and then offer a different amount of financial aid to each student based on need to discount it. Thus they charge each student a different amount based on their ability to pay.

In the fascinating book Inside American Education by Thomas Sowell, Sowell reports that from 1956 to 1990, the leaders of about two dozen of the most elite colleges and universities met to determine in advance the exact net amount that any of them would charge students who applied to more than one of them. This attempt to limit the effects that competition has on prices constituted a cartel. The cartel was disbanded in 1991 after the Justice Department launched an investigation.

Sowell's book was published in 1993, and I don't know if any similar cartel has existed since then. But college prices continue to increase at well above the level of inflation. Colleges continue to charge different prices to different customers.

As Sowell points out, when colleges say that costs have increased, this is equivalent to saying that they chose to spend more.

Once again, government subsidies make things worse, not better.

1 comment:

Anonymous said...

Check out "Going Broke by Degree" by Dr. Richard Vedder.