The economics of higher education 101

((Butch Dill – Associated Press) )

The cost of going to college is one of the most difficult issues facing education policymakers. Here Catharine Hill, president of Vassar College in Poughkeepsie, NY, explains the basics of higher education economics.  During her almost seven years as president, Vassar’s signature effort has been re-instituting need-blind admissions and maintaining a commitment to full need-based financial aid for all four years students attend, even as demand for aid has significantly increased.) More than a decade ago, Hill began examining the admissions and financial aid practices of the nation’s most selective colleges and universities, with a key focus on students who have strong academic qualifications and are from families in the lower 40% of the national income distribution.  PDFs of her papers are available via .

  By Catharine Hill

This semester, I am once again teaching a course in the Economics of Higher Education at the college where I also happen to be president. Since my academic background is in economics, the course combines several of my interests. The students who enroll in this course have always been interested in a look behind the curtain, too.
To understand the current criticisms of the cost of American higher education, some basic explanation of economics is needed. To begin, the cost of education is what is spent by a college or university to educate a student. The price is what a student is asked to pay for that education. This price is almost always less than the cost, with differences covered by a subsidy received by all students. This subsidy is enabled by federal and state support of various types, including state appropriations at the public institutions, and gifts and endowment earnings at the private non-profits, both encouraged by favorable tax treatment. Next, there are scholarships and grants, based on merit or financial need, which reduce the price for some students, increasing these students’ subsidy beyond that received by all students. Cost has been shown to be positively related to both the reported price and the general subsidy. The schools that spend the most on each student charge the highest prices but also offer the largest subsidies. 
These simple economic relationships have several implications and highlight several important issues that should be the focus of public policy. The largest subsidies go to those who attend the highest-priced schools, which tend also to be the most selective. These subsidies are supported by a variety of federal and state policies. Despite significant amounts of need-based financial aid and many schools that are need-blind and meet full need, admissions and matriculation at these schools depend on an applicant’s income, not just academic success, so that access to the large subsidy supported by public policies at these schools depends regressively on income. 
It is an open question whether an additional dollar of public spending would serve the public good more if spent on higher-achieving rather than lower-achieving students, but there is no reason to think an extra dollar on a high-income talented student will be more valuable to society than an extra dollar on a low-income equally talented student. When a dollar of financial aid is cut to hold down tuition, for example, at a minimum it is a transfer of a dollar from a needy student to a full pay student. But, if it results in that needy student going to a different, less expensive school with a smaller subsidy, it also results in a transfer of the higher subsidy at the original school from the needy student to a higher-income student.
Current discussions of tuition may be leading to bad public policy, even if they are politically attractive to upper-middle and high income families. It’s simple. Cuts to financial aid have the greatest impact on the neediest students. Higher ed leaders and policy makers must remember basic economics.

Valerie Strauss covers education and runs The Answer Sheet blog.
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Valerie Strauss · November 22, 2012