Price Discrimination Explains College Tuition
Why so many students get discounts
college prices are distorted by a system that deliberately lists tuition levels much higher than what students pay. The practice has caused needless anxiety for millions of families, forced college leaders onto an annual high-sticker-price/high-discount merry-go-round, and distorted our national conversation about student debt.
He points out that list prices for tuition mislead the public in many ways. For example, he reports that although average full tuition at private colleges rose 33 percent from $27,000 in 2004 to almost $34,000 in 2020, average tuition paid actually edged down, from $15,000 to $14,000. Scholarships and grants increased over those fifteen years.
Currell fails to provide what I see as the economic explanation for the use of scholarships to reduce tuition. He writes as if every student received a discount, and the goal of the posting a high tuition is to make attendance at a college appear to be a precious luxury.
For many years, I have been saying that “price discrimination explains everything.” For many businesses, marginal cost is low relative to fixed cost. You do not want to charge the same price to every customer. If you charge marginal cost, you will lose money. If you charge average cost, then you will drive away customers who are willing to pay above marginal cost but below average cost, so that you forego profits from those customers.
Currell writes,
higher education is an overwhelmingly fixed-cost business, and few colleges fill their incoming classes. As a result, market-clearing tuition for the marginal qualified student the day classes commence is, at least in theory, $1
When you have an overwhelmingly fixed-cost business, price discrimination is the best solution. Charge a low price to the customer who is most likely to be driven away by a high price, and charge a high price to the customer who is more willing to pay a high price.
How does a college identify the suckers who are willing to pay full tuition, or something close to it? Get parents to disclose their finances. Get students to apply for “early decision.” Find out which students are getting generous government loans.
Colleges also want to offer attractive scholarships to students whose parents are likely to give generously to the school. “Legacies” get scholarships for that reason.
By the same token, colleges do not want to induce children in poverty to attend. They try to offer scholarships to students of poor families that fall just short of what would be a sufficient discount needed to entice those students to enroll.
Although most colleges are “non-profit,” they are among the most ruthless profit-maximizers out there. They pay economists and statisticians to implement algorithms to calibrate scholarship offers to obtain the students they want without giving too much away. In addition to price discrimination, they also engage in wage discrimination, competing for prestige faculty with high salaries while paying hapless adjuncts who do much of the teaching less than a living wage. They approach fund-raising with zeal, applying sophisticated techniques, large staffs, and capital campaigns to finance lavish facilities. Finally, higher education is one of the largest lobbying industries in Washington.
Ideologically, the campus may be hostile to capitalism. But as businesses, colleges demonstrate capitalism at its most cutthroat.
UPDATE: David Eubanks pointed out that upperclassmen receive lower discounts than freshmen. This can be explained by price discrimination, since upperclassmen face a higher cost of choosing a different institution.
This essay is part of a series on human interdependence.
Ideologically, the campus may be hostile to capitalism. But as businesses, colleges demonstrate capitalism at its most cutthroat.
I worked in at a University for twenty years. by the end of year 4 I was convinced that the above quote is the absolute truth.
Sharp essay! A few wrinkles about tier-one private colleges:
1) Re: "Charge a low price to the customer who is most likely to be driven away by a high price, and charge a high price to the customer who is more willing to pay a high price."
There remains a puzzle: Why do all of the selective private colleges post approximately the same tuition price, despite great differences among them in (a) selectivity (excess demand) and (b) endowment-per-student?
Note: Each of these differences may range up to an order of magnitude! Surprisingly, if I recall correctly, most of the tier-one national liberals arts colleges have approximately the same proportion of students of pay full tuition: roughly 40%.
In other words, why do Princeton, Harvard, Yale, and Stanford leave tuition money on the table? Their markets would bear a higher price for a substantial fraction of matriculants, yet they post the same tuition price as NYU and Boston U.
To put it another way: Why does competition among Princeton, Harvard, Yale, and Stanford for stellar students entail the same posted tuition price as competition among NYU, Boston U., and Georgetown U. does?
2) Re: "How does a college identify the suckers who are willing to pay full tuition, or something close to it? Get parents to disclose their finances. Get students to apply for 'early decision.' Find out which students are getting generous government loans."
Why don't colleges use a simpler, efficient indicator: Zip code of applicant?
Here is part of the answer: By requiring the subset of parents, who wish to be eligible for a tuition discount (price discrimination), to disclose their finances, the college can cloak price discrimination in the rhetoric of "ability to pay" (i.e., progressive pricing). Price discrimination sounds bad, whereas need-based financial aid (and also merit scholarships) sound good. ("Merit aid" is mostly calibrated as a tool of price discrimination.)
Note: The majority of "early decision" matriculants at tier-one private colleges are in 2 categories: (a) recruited athletes and (b) "underrepresented minorities". A disproportionate fraction of "financial aid" (tuition discounts, price discrimination) is allocated to athletes and URM students in the early-decision rounds. Colleges fear that they would risk shortfalls in these categories, which they consider politically strategic, were they to rely mainly on the regular April round of admissions to fill them.
3) re: "Although most colleges are 'non-profit,' they are among the most ruthless profit-maximizers out there."
At the risk of splitting hairs, I would say that colleges aren't profit maximizers because they have no 'residual claimant' of revenues. Instead, they seem, very roughly, to maximize some mix of current revenues, endowment growth, and prestige (academic, athletic, social, political) -- all subject to rent-seeking by insider stakeholders.
PS: Re: "Colleges also want to offer attractive scholarships to students whose parents are likely to give generously to the school. 'Legacies' get scholarships for that reason."
Are you sure that a substantial fraction of legacy matriculants receive major tuition discounts? My impression is that, at least at tier-one private colleges, legacy matriculants usually pay the full posted tuition. The controversy around legacy students is about the occasional practice of matriculating a legacy student in place of another student who has a better high-school academic record. There are two standard rationales for such 'legacy preferences' in admissions: (a) These students improve 'retention' (an important performance metric for colleges). They know what they are getting into, and so almost never transfer to another college after their freshman year. (b) Often, their families make substantial gifts to the college. Colleges predict/expect that the legacies will continue the philanthropic tradition -- and help endowment growth.