Economics Question: College Returns vs. Tuition Costs
No one's posting on the blog. In an effort to liven up discussion, I thought I'd occasionally post some economic questions or puzzles that I've been thinking about recently. Hopefully people can spend a few minutes thinking about the issue and we can get an actual discussion about economics going.
One question I was thinking about yesterday is about the rising wage premium over the past 25 years for college graduates. It's a pretty well accepted fact that, even though the supply of college graduates has increased over that time period, the return from going to college has increased even more. There has been just an enormous increase in the return from becoming skilled over the past 25 years. There's a lot of interesting issues about the causes of this increase in the skill premium in the U.S. which I've been going over for the past two weeks in my applied micro class, such as inequality concerns, changing marginal productivities, and whether the trend is supply or demand driven.
My question, however, relates this data to the market for college. When you look at tuition costs over the same time period, you see a similar trend, but with a much smaller magnitude. Rough estimates say that college tuition costs have reduced the apparent gain in the skill premium by as much as 50%. The question: only 50%??? The undergraduate market is huge, with millions of consumers and a few thousand suppliers. Why are there still profits to be had by the millions of consumers? Shouldn't the returns from going to college equal the costs of going to college? Note that college as signalling isn't particularly germane to this question - the return is the return, regardless of whether it's a productivity improvement or a signalling game.
With some help from a friend, I have an answer I like. But I'm curious to hear what other people think is going on.
posted by Andy @ 10:04 AM
5 comments
5 Comments:
I had a lively discussion in my office today about this to see what my classmates though, and the first story we came up with to help explain this phenomenon would be along the following lines:
Can't some of this can be explained by competition between private institutions and public ones (I'm thinking UNC vs Duke here, competing for out of state students? Clearly public universities will not increase prices to close off these "profits" but private ones ought to. However, since private schools have to compete with publicly funded universities (in terms of tuition costs), they can't raise prices as quickly as the market mechanism might suggest they should.
And, as Mike enjoyed reminding me last year, the primary state university is typically seen as as good a choice for school in terms of future outcomes as any private program outside of your region (especially when you consider the average experience outside of New England -- mind you, I have no data to support this, just Mike's sayings).
That's what I've got...
I like Ariel's answer.
Of the 248 universities classified by US News as "national," 162 are public and 86 are private. The public schools (which I am certain have more than twice as many students as the privates) are not in the business of making profit. One would not expect the private cost of public education to equal its return. A more interesting quesiton would examine whether the social cost equals the social benefit, since public university education is financed by tax payers.
Remember that there are two or three thousand degree granting institutions in the United States which charge dramatically different amounts for tutition. Among these, according to US News, there are 246 national, doctoral granting universities, 215 liberal arts colleges, 557 "master's degree" colleges, and 320 "comprehensive" colleges.
Don't talk about UNC and Duke, they are too similar. Talk about the University of Missouri - Saint Louis and Washington University. UMSL is publicly funded and should try to keep tuition low, whereas Wash U is private and, in theory, would try to eat up those profits.
However, I imagine that there is a critical value where the private tuition minus public tutition is large enough that private schools would see a damaging drop in their enrollments.
My own experience points to this. The tuition at the private schools I was looking at (many of you went to them!) were so much more than the tuition at the University of Kansas that my dad told me that he would pay for the cost of KU and that I would have to make up the difference. He thought that KU, which cost about 5,000 dollars a year, was not 20,000 dollars worse than Columbia. The higher Columbia's tuition, the more people who come to my dad's conclusion.
I realize I didn't add much new here! Just thought I'd chime in...
My personal answer to the question was that the question was actually pretty low quality - it confuses average and marginal gains. If the market is competitive, there's no reason at all to think that the average gain will equal the gain to the marginal guy, who is the important determinant of observed prices. In other words, the wage premium reflects the (average) consumer surplus in the market, but the tuition cost reflects the marginal benefit of the guy who is totally indifferent between college or not.
Of course, if you believe that colleges are all little perfect price discriminators (as David did), then there's a real question. I'm pretty skeptical that there's a great deal of monopolization here - yes there's some product differentiation, but college decisions are always attempting to play one school off another. I think there's just too many agents on both sides of this market and pretty closehomogeneity of the product for this market not to be competitive. Regardless, even with monopolies, consumers still get profit from interacting with the market, and that will still be true here.
As for a couple specific points people brought up:
- public vs. private school. One common theme in public finance is that public provision tends to be efficient if it's provided in a competitive fashion. To that extent, I don't think state subsidies can explain a lot of the difference. In particular, I don't believe that any state is subsidizing their state schools to provide education at below cost, let alone several states.
- credit markets. Aren't there really quite good credit markets available for people entering college for the first time? Very, very low rates, generous repayment plans. I understand that the lack of proper collateral hurts this market somewhat, but the government has thrown a lot of money at student loans to help overcome this problem. I don't actually know if the market is perfect, but I'm suspicious of claims that it's in terrible shape. Furthermore, I don't see how that effects the observed outcomes at all. If students can't pay, won't they just not go to college. The market forces operating on the rest of the college students is intact, so marginal costs/gains should still align.
- ex post wage variance. Could you explain this more David, I don't get it. First off, are is the claim that college changes the wage variance? If it's just a mean-shift in the distribution, then they should be able to capture it all (assuming monopoly, etc). Instead, perhaps the claim is that going to college increases wage variance, and, being risk averse, consumers are less willing to pay for college, hence the lower tuition cost. I suppose that might work, although, in my opinion, seems a little far away from what we actually think of when people are making college decisions.
Andy, you said, "I don't believe that any state is subsidizing their state schools to provide education at below cost, let alone several states."
Ok. I never argued that states do subsidize universites to operate below their costs. I was trying to say that public universities might charge tuition at cost regardless of the profits that are potentially available by raising tuition fees. (I'm tired, so this might be entirely wrong, but) Essentially it would amount to public universities setting prices somewhere on the inelastic portion of the students' demand curve for education, where raising prices would increase profits, and they arbitrarily choose not to effect such increases.
I don't think that's an unreasonable assumption to make given that the state's objective might be to minimize the price of tuition not to maximize the profit of universities (although the economics of this statement sound dubious to me right now).
Clearly, this is would not efficient, but isn't gov't policy (in a welfare state like ours) "usually" inefficient precisely because it may not care about total welfare but about the welfare of the worst off?
I could be missing something obvious, but I just don't see it.
All that aside, I like Andy's breakdown of how the question confuses average and marginal gains.
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