Each year around this time, we see a spate of stories about skyrocketing college tuition rates. Here on Warren Reports, we’ve worried about the resulting debt-burden for those in the lower and middle class, who may or may not earn enough to offset the costs.

But this article in last week’s New York Times turns conventional wisdom on its head. Turns out that when colleges hike up prices, their market share goes up! That’s right – since students and their parents have no real means of comparing colleges according to educational quality, they instead resort to the bottom line. If its pricier, then surely it must be better!

If you were on the board of trustees and were facing this reality, what would you do? Hmm – do we want to have less money, less prestige, and fewer top students? Or, shall we jack up tuition again this year?

Below the fold -- who does this really help and hurt? And is this a case-study in educational competition gone awry?

If the colleges are using the surplus money for need-based financial aid, as the NYT article suggests, then at the end of the day, the price-hikes may be a good thing for poorer students. Ideally, any supplier would like to customize its pricing – setting a price for each individual at precisely the maximum he or she is willing and able to pay. That appears to be what colleges are doing here. (Outside of higher education, most suppliers have to set a single price, which prevents some consumers from buying at all, and gives others a bargain price, below what they would be willing to pay.) To think about it another way, these college tuition price hikes, plus more need-based aid, are a form of wealth redistribution – the wealthier students subsidize the tuition of the poorer.

Of course, that all assumes that the colleges really are using the fee hikes to waive tuition for the neediest students. Other factors may be at play, like the seven-digit salaries for college presidents and the private jets, not to mention the posh gyms and dorms which college kids now expect.

But is there another wealth transfer going on here? Higher tuition means that students are eligible for more loans, some of which are subsidized by the federal government. And, if the fee hike means more students pay some tuition out of pocket, then that makes them eligible for the HOPE and lifetime learning tax credits (IRS, pdf). So to some extent, these fee hikes increase the federal government’s subsidy for higher education, without necessarily increasing access.

One little wrinkle may arise if some students do not understand the funny money game. Instead, when they see a local public college charging $5000 a year, and a private school charging $25,000 year, they may not understand that they'll really only pay $2,500 at either school. Some students will be deterred from applying to the pricey schools, which will set back the colleges' goals for diversity and economic opportunity.

So, colleges provide an interesting example of a quasi-free-market. Yeah, they are competing with each other, and from an ideological perspective that's great. But rather than competition causing prices to go down and quality to go up, it may be doing the reverse. Part of this is a result of consumers having little real information, and part of it is a convoluted funding system. But are there perhaps lessons here for the debates over primary education, where competition is supposed to solve everything?

UPDATE: 1/09/07 Today the NYT reports on at least one example where college's decision to raise tuition can cause students to go elsewhere. The NYT writes,

Last spring, Pace [University] announced that it would raise annual tuition for new students by 19 percent, to $29,454, nearly double what it charged in 1999, the year before Dr. Caputo took office. The number of new full-time freshmen plunged 23 percent in the fall, to 1,131. Faced with projections of a revenue shortfall of nearly $30 million — about 10 percent of its budget — the university imposed cutbacks and a hiring freeze.