By Richard Vedder
The most well established of all the "laws" of economics is the Law of Demand: when something becomes less expensive, people buy more of it. In economics textbooks, we usually discuss rare exceptions to this law, talking about "Giffen goods" or "snob effects," situations where the quantity demanded may actually rise with price.
Jonathan Glater and Alan Finder suggest in today’s (and tomorrow's) New York Times that the tuition explosion may partly be a consequence of a snob effect in higher education: higher tuition charges are perceived to mean higher quality, and with higher quality comes greater numbers of applications. The authors give examples (e.g., Ursinus College in Pennsylvania), that seemingly fit that description.
Two factors might help explain the results reported by the Times. First, massive amounts of third party payments, including institutional aid financed by the universities themselves by charging the very affluent through the nose, has reduced the sensitivity of customers to price. Usually, we think that means customers go from being highly sensitive (elastic demand) to becoming insensitive (inelastic demand), but it might even go further --customers become "snobs", wanting to buy "the best" and equating price with quality.
A second factor is that elite colleges are social networks, sort of academic country clubs, and that jobs often come from contacts developed at the university. The more expensive the school, the more elite the student body is likely to be, the more "pull" their parents have, and the greater the probability that graduates will get good jobs through university-developed social connections. Universities that jack up their sticker prices a lot can sock it to the rich legacy candidates for admission who have indifferent test scores, without overtly accepting bribes (which, however, if enough money is on the table, they will do via "development admits", as Dan Golden has so vividly shown us).
The irony in all of this is that perceptions about quality may in fact be way off. It is interesting that the very best schools as perceived by the public -- the Princeton’s and Harvard’s --charge little or no more than the merely "pretty good" schools like, say, Notre Dame, George Washington University or the University of Southern California. They (the top schools) use a relatively low price (relative to demand conditions) to turn down a huge proportion of applicants, allowing them to cherry pick amongst the rest, taking a majority of students on merit considerations and the rest for other reasons, including their ability to increase already obscenely large endowments via tax deductible gifts.
The authors appropriately note, however, that the Law of Demand is not dead. Muskingum College slashed its tuition in the 1990s (also drastically reducing institutional financial aid), and had generally favorable results, getting large increases in applications. I have always thought some entrepreneurial school could increase its rankings simply by drastically reducing tuition (financed largely by reducing institutional aid), thereby getting an increase in applicants from moderately affluent (but not uber-rich) students, and turning more students down, adding to an elite image. The Times story says the opposite approach, raising fees drastically, can have similar payoffs. That is what makes our world so interesting - "different strokes for different folks."