NCPA - National Center for Policy Analysis

College Pricing Undermines Financial Aid

April 4, 2011

While financial aid is designed to increase access by lowing prices, recent increases in financial aid have not improved affordability and have therefore not increased access, say Robert E. Martin, emeritus Boles Professor of Economics at Centre College, and Andrew Gillen, research director at the Center for College Affordability and Productivity. 

The idea behind financial aid is quite logical, but it rests upon the assumption that universities do not change the price because of the subsidy.  For items provided in competitive markets, the assumption that a seller cannot respond to the subsidy by raising the price is likely valid.  But in higher education, colleges and universities set their own prices.  Indeed, colleges and universities have considerable pricing power which is evident by their ability to raise prices when state governments reduce public support.

  • Since the value added from obtaining a college education is uncertain, competition between institutions is driven by academic reputation.
  • Due to this persistent uncertainty, each institution must signal quality through expensive proxy signals, such as the quality of their students, research, facilities or athletic teams.
  • If an individual institution forgoes capturing increased financial aid dollars, it cannot compete; its status will decline as will its ability to attract good students.
  • This behavior is reinforced by the fact that students and their parents associate high cost with high quality.

Higher education is engaged in an expenditure arms race that thwarts policies to increase public access and redistributes wealth to higher education insiders, say Martin and Gillen.

Source: Robert E. Martin and Andrew Gillen, "How College Pricing Undermines Financial Aid," Center for College Affordability and Productivity, March 2011.

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