Why Does College Cost So Much?
There’s been an incredible amount of debate during this election cycle about college costs, and much of the debate has ignored fundamental economics. The reason that college costs so much is simple: demand exceeds supply. Take a look at this oversimplified chart:
This is economics 101. Supply and demand are inversely related to each other. As supply increases, demand diminishes. If there’s little supply but a lot of demand, the price to buy is high - the purple arrows. If there’s plenty of supply but little demand, you may actually have to pay people to take your stuff.
If there’s little supply but no demand, prices stay low. If there’s lots of supply and lots of demand, price will follow whichever is higher - more supply than demand means lower prices, more demand than supply means higher prices.
Examples
If everyone wants a Nintendo Wii for Christmas, and there are fewer Wiis than there are customers, the price can go up until you reach the point where it’s only affordable to as many people as there is supply. The higher you raise the price, the fewer people who can buy it, until price and supply are in equilibrium.
If you try to sell blades of grass, you have a giant supply but almost no demand. Who wants a blade of grass? As a result, not only can you not even give away your blades of grass, you may actually have to pay people to take them, which is the blue line on the right side of the chart.
If you are trying to figure out why college cost so much, it’s because we’re on the left side of the chart, low on the green line. There’s a lot of demand for college, and not a lot of supply. Look at the admissions statistics for this year. Competitive colleges accepted fewer students than ever. Demand for a college degree is high and increasing as our economy changes from a manufacturing economy, where a high school degree was more than enough to get you through life, to a knowledge economy, where a college degree is a basic prerequisite for many jobs.
As a result, with not a lot of supply but a lot of demand, tuition prices are high. As demand increases but supply doesn’t keep up, tuition prices get higher.
How to lower the cost of college
Logically, there are two ways to alter the price of a college education, then - reduce demand or increase supply. Right now, the market - you - is saying that college is worth paying for, largely because the job market creates demand for a college degree. The price of college will continue to increase until a certain percentage of the population can’t afford it, at which point demand would be in equilibrium with supply.
Financial aid makes college more expensive
This is why financial aid is actually making college tuition prices worse, believe it or not. Financial aid alters demand - the more money available in financial aid, the more demand there is. A college that costs $10,000 without financial aid still costs $10,000 with financial aid - the financial aid just comes out of taxes or from student loans that borrow from a student’s future earnings.
At the same time, colleges aren’t easy to create or run. They’re big things, with buildings and professors and all those capital costs. As a result, supply isn’t easy to create.
As a result, prices go higher because demand is outrunning supply. If financial aid didn’t exist, there would be far fewer customers for colleges (lower demand) and colleges would either have to accept a much smaller student body or lower prices until demand rose to equal supply.
Financial aid makes college cost more because it increases demand and does not change supply.
How to lower the cost of college, part 2
The second way to lower college costs is to increase supply. If supply increased to exceed demand, prices would come down.
Fundamentally, the lesson is this: until supply increases or demand decreases, college will continue to get more expensive. As our economy continues the transition to a knowledge-focused economy, the demand for higher education will continue to increase, so if a large number of citizens educated well is a national priority, the most rational choice is to increase supply. If a large number of citizens educated well is not a national priority, then the rational choice is to eliminate financial aid and let the market - the basics of supply and demand - re-price college.
What does this mean for you?
As we head into election season and proposals of all kinds are thrown out about how to make college more affordable, now you know the question to ask - will this increase supply or decrease demand? If a proposal doesn’t do one or the other, it’s not going to work, no matter what the politician says. Throwing more money at the financial aid system will increase demand without an increase in supply, so beware of candidates who propose that solution.
Distance learning and online learning stand the greatest chance of reducing the cost of a college education because they can create supply faster than building a physical college. It doesn’t matter whether a professor has 1 student or 100,000 students watching a pre-recorded video - the cost of that professor’s time is the same, especially if colleges continue the trend of using graduate students and adjunct faculty for administration and testing.
How can you make college more affordable for yourself? Simple. Because a college degree is in demand, lots of people are trying to get them. Back to supply and demand - if supply is outpacing demand, then the value of the supply goes down. If more and more people have a college education, every additional graduate diminishes the value of the degree if demand doesn’t keep pace. As a result, this means that having a “name brand” degree from a “top college” really doesn’t mean much outside of a few limited circumstances. Having a degree is what matters.
This means that getting a degree from a lower cost college is the most rational choice and the best way to lower the cost of what you have to pay for a college education. If one degree is as good as the next in the job market, then why pay $20,000 to obtain the same entry level job that a $5,000 degree can obtain?
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Interesting- I never really thought of Financial Aid as being co-dependent with tuition and artificially inflating prices.
September 2nd, 2008 | #
Excellent article. Andrew Jackson University is that low cost college you are talking about.
However, one additional thought - it may actually be a case of over supply. Since federal aid is readily available and students can defer their cost while they study, students may not be factoring the cost into their decision. The result is that the amount suppliers receive is far greater than what demanders pay (assuming loans are largely discounted as a factor, given the long range payment), then suppliers end up over-supplying the market and operate on the inefficient portion of the supply curve. A piece of evidence to support this claim is the excess amount of spending being done in internet advertising.
To explore this very topic, Andrew Jackson University is teaming up with the Department of Economics at San Jose State University.
Either way, the choice is clear - students should look for lower cost option - those schools who can provide a high quality education at a low price!
Don Kassner (MA Economics)
President
Andrew Jackson University
September 2nd, 2008 | #