The Economics of College Tuition Fees
Lina, Olivia, Xinyang and Yang
If you are sensitive to price changes and the money you (or your family to be more specific) spent, it’s not too hard to notice that the tuition fee of Mount Holyoke College is increasing through your staying here and that everybody’s bill has a different number on it. Why is that?
In the 2011-2012 school year, Mount Holyoke’s tuition is $41,270. Room and board cost $12,140. Including student activities fee of $186, the total amount is $53,596. ( Type in the following website address to check the latest tuition fee number: http://www.mtholyoke.edu/admission/tuition_finaid.html. ) According to an online ranker website DMVFollowers, this year Mount Holyoke ranks #66 among the top 100 most expensive colleges in U.S. (http://www.dmvfollowers.com/?p=3631) Taking into account the quality of education that has been offered here, this ranking doesn’t look too unreasonable. However, it should not prevent us from exploring the economics behind college tuition fees either.
According to the College Board, the average cost of tuition and fees (including costs for books, transportations etc.) for the 2011-2012 school year is $42,224 at private colleges, $21,447 for state residents at public colleges, and $33,973 for out-of-state residents attending public universities, while the U.S. median total household income is only $49,445. This partly explained why the amount of student loans taken out exceeded $100 billion last year.
How does economic theory explain the expensive and constantly increasing college tuitions fees?
One obvious reason could be resulted from the development of new knowledge and programs. However, William Bowen has proposed a theory in 1967 attributing the constant increase in college tuition fees to the fact that higher education institutions were not sharing in the productivity gains that applied to the rest of the economy. For example, in a college like Mount Holyoke where student vs. faculty ratio is almost fixed, faculty productivity doesn’t increase over time (because they always teach fixed number of students). While in other industries, increasing productivities push wages to go up. Therefore, if the college administrators restrict tuition growth rate to inflation rate, faculty salaries would fall behind the earnings of other professionals, which is not beneficial for colleges in the long run.
In terms of profit maximization, it’s hard to judge whether high prices are optimal for colleges because the demand curve for college admission is downward sloping. The higher the tuition fee, the fewer the people who would be willing to pay. Thus theoretically, all colleges would eventually reach a point where increasing tuition fee causes shrinking profits.
Then what do colleges do to improve the situation and enhance their profits?
Unlike pure monopolies, colleges have a tool that doesn’t exist in most other industries: colleges can charge different prices for each individual student by granting different amount of financial aid!
In a monopolistic model without financial aid, the college can only pick one price (p_1, p_2 or p_3):
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In the graph, revenues are areas of the rectangles.
However, if we include financial aid into the model, each one extra unit can take a different price. For example, if we just want to limit our price to be below p_1 and above p_3, we can get the whole area below p=p_1 and the demand curve, and left to q=Q_3.
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