Elite College ($50,000 a Year) or Good State School ($20,000)?

The new Sallie Mae-Gallup survey of attitudes toward higher education, “How America Pays for College 2012,” shows that Americans are becoming increasingly resistant to rising college prices. Some people who were saying “I want the best college money can buy” a few years ago, are now saying “We aren’t going to pay sky-high tuition when there are much cheaper colleges nearly as good.”

How sensitive are people to price? I woke up in the middle of the night with a minor epiphany about this. My surmise is that, by and large, in the era before massive federal student loan programs and also smaller private scholarship offerings, the demand for college was highly elastic–people were extremely sensitive to price. In, say, 1925, when family incomes in today’s dollars were typically perhaps $20,000 or $25,000, the cost of any school was burdensome, and the Ivy League, costing perhaps $8,000 or $10,000 a year for all costs (in today’s dollars), was a luxury for the truly rich, while state schools, costing perhaps $4,000 a year, were available for some middle class people but by no means all.

Fast forward to today. Incomes have doubled or tripled, but the cost of college has gone up far more -five or six fold. The availability of loans and the development of a culture arguing that higher education is a good “investment” has made the demand for college not only larger, but also far more insensitive to price. A good college is now considered a necessity of life, almost like salt or life-sustaining drugs, whereas earlier it was what John Stuart Mill might call a “superfluidity.”

Yet are the survey data correct? Applications for the very top private schools -Ivy League, M.I.T., Stanford, Duke, Northwestern, Williams and other top liberal arts colleges and a few others, are booming. Yet there is something very strange about college pricing. When you buy an extremely luxurious car, you pay maybe three times what you would pay for merely a nice car -say a top of the line Mercedes Benz compared with a Toyota Camry or Chevrolet. But the most desired colleges -the Harvards and Princetons – cost about the same as the merely good quality schools, say George Washington University or Sarah Lawrence College. The situation is even murkier because higher education performance data are nearly non-existent. What is Harvard’s “frequency of repair” rate, for example? Who really knows whether Princeton is better than George Washington University?

The So-called ‘Scholarship’ Aid

Students who face little chance of getting into an Ivy League school or select liberal arts college (Williams or Amherst in the East, Pomona in the West) are increasingly asking: why should my family pay $30,000 to $50,000 a year (the exact amount unknown at the time of application because of uncertainties arising from  massive price discrimination in the form of so-called “scholarship” aid) to go to a mid-quality private school when for somewhat less, say $20,000 to $30,000 a year, I can go to a top public flagship school of roughly equal quality?

Amongst students who are still poorer academically as well as financially, the lure of borrowing huge amounts to finance an otherwise financially unsustainable college education is declining. Too many college students are ending up with relatively low-paying jobs unrelated to their field of study. Benefits of attending college are falling, costs are rising. For some, the decision may be to “just say no” to college altogether. For others, demand has become highly price elastic: the substitution may be to go to a community college or a for profit school’s certificate program rather than the mid to low quality four year state school.

That is why I feel pretty safe in predicting that Harvard, Stanford, Duke and Northwestern will be doing fine 10-20 years from now, cushioned also by their large endowments. But I am far less sanguine about the poorly endowed liberal arts college and state university with a so-so national reputation. The Law of Demand is going to hit these schools with a vengeance as increasingly price sensitive customers look for cheaper substitutes.

One implication of the rising elasticity of demand is that tuition price hikes at non-selective schools at some point produce less revenue, not more. Colleges have tried to avoid this by ever greater use of differential pricing, charging the “rich” (whose demand is less sensitive to price) more than the poor. The federal government facilitates that by its nefarious FAFSA (Free Application for Federal Student Aid) form, which gives colleges lots of private financial information about their customers. But they have now largely maximized their ability to squeeze dollars from this practice.

The role of colleges as screening devices, sorting out the ably and productively ambitious from those with lesser talents and drive, is changing rapidly, and colleges are slow in realizing it.  We are moving to a two-class college system -the elite schools whose graduates are still viewed as superior in many traits, worthy of good starting jobs at nice rates of pay, and the less distinguished colleges where a bachelor’s degree connotes little about the individual’s ability to perform in the world of work, and where, therefore, the employment experience of new graduates is less successful. The demand for the elite schools remains strong and relatively price insensitive, in contrast for the weakening and more elastic demand for the less elite schools.