The Law of Demand Works at Harvard

By Richard Vedder

There are some persons who say that at private American universities, the demand for education varies POSITIVELY with price --when universities raise their fees, more, rather than fewer, apply. If true, this is one of the relatively few significant examples of what economists call a "Giffen good," or the "snob effect," where raising prices leads to higher demand as customers perceive an improvement in quality associated with higher price.

I have always thought the demand for elite colleges was relatively inelastic, but still negative --higher prices scare some customers off. The whole issue is clouded somewhat by the widespread tuition discounting followed by virtually all schools, so the sticker price is greater than the average price ("net tuition fee") paid by students.

I have a mole, so to speak, at Harvard, with an inside scoop on admissions applications. Last year, Harvard had roughly 23,000 applications and, given poorer economic times this year and a virtually unchanging sized senior high school class, one would expect applicants for fall 2008 to be similar to this school year, or perhaps up 1-2 percent. Harvard, however, announced several weeks ago its new pricing plan that very publicly drastically lowers tuition fees for huge numbers of Harvard students. Most important, applicants from families with incomes below $180,000 a year know now exactly what they will have to pay when they apply --unlike most applicants, who learn of the net price only much later. Hence sticker prices are relevant at most schools, since they indicate the amount students might have to pay if turned down for financial aid (and typically 40-50 percent of students in fact DO pay these prices at top schools).

In fact, Harvard had a huge surge in applicants --over 27,000 I understand --close to a 20 percent increase. A lot of middle class parents whose kids failed to apply to Harvard thinking "it will probably cost me $30,000 or even $40,000 a year," now are applying. If the family income is $150,000, they know the cost will be only $15,000 --less than costs at the best state schools. Hence Harvard applications are soaring, presumably mostly from kids from families with $60,000 to $180,000 income benefiting from the new plan. It appears among students in this financial situation, demand is pretty elastic -- price matters.

The interesting thing is: will this change the nature of the Harvard entering class in any way? While truly poor kids were already told they would pay nothing if they went to Harvard, now Harvard is appealing to more kids from prosperous middle class families relative to the elite.

All of this means Harvard will reject more kids then ever. Other schools are responding to the Harvard initiative --in part to win over some of the growing number of Harvard rejects who are still very good students by almost any criteria, and partly to try to up their own applicant pool that may actually be falling in the way of the Harvard (and Yale) initiative.