Why Do Subsidies Make the Price of College Go Up?

So I have a question for the Ricochetti:

The reason why we have high fructose corn syrup in the U.S. is (at least mostly) because we have corn subsidies that keep the price of our corn artificially low.  Somewhere along the line, some clever people found a way to turn this super cheap and plentiful corn into a super cheap and plentiful syrup.

With higher education, we have all sorts of subsidies (loans, gov’t grants, etc.) yet the price of college has increased 1000% in real dollars since 19…

  1. Doug Kimball

    There is the “price” of college, as advertised and then the actual cost of college, which is the total cost to operate the college divided by the number of students attending.   There is also the average amount a student is charged, net of grants and scholarships.  Each of these figures is relevant.  At a public university, donations and state and federal monies cover a large portion of university operating costs.  The balance is paid primarily as tuition and fees.  At private universities, alumni donations, grants and endowment income make up a protion of operating costs.  Tuition must cover the rest.  How these revenue sources compare among colleges would be an interesting doctoral study.

    However, in answer to your question, why has college cost gone up, the answer is simple: the Kimball Rule.  The Kimball rule asserts that absent a profit motive, an organization will spend whatever it is able to garner and this level of spending will then become a new baseline for future spending.  For example, if a private college has a stellar year collectiong donations from alumni, it will not lower tuition rates for students, but expand spending. 

  2. Roberto

    Supply-demand mismatch. Higher education is not a commodity product; there is only one Harvard, there is only one Yale and all institutions only have a limited number of spaces for applicants. Yet demand is continually increasing due to pressures the government has brought to bear.

  3. Lucy Pevensie

    A lot of the subsidies for education are in the form of loans to cover tuition (student loans). These effectively shift the demand curve to the right and thus cause the price of an education to rise.  It’s entirely analogous to the effect on housing of increasing the availability of mortgage loans (for example, to people with substandard credit scores). 

  4. Schrodinger

    Your corn comparison is inapt.

    What the government subsidies in education are doing is the equivalent to the government giving subsidies to grocery shoppers to buy products which use corn. Demand increases causing price increases.

    Currently, the Feds subsidize corn growers (producers), while in education, the Feds subsidize consumers (students). Subsidize producers prices stay low, subsidize consumers prices go up.

  5. Jim  Ixtian

    This article might be somewhat dated but it gives an excellent account of the problems. Some depressing lowlights;

    Higher education seems an unlikely site for this kind of speculative bubble. While housing prices are based on what competing buyers are willing to pay, postsecondary education’s price is supposedly linked to its costs…

    …So why would universities raise tuition so high so quickly? “Because they can” answers this question for home-sellers out to get the biggest return on their investments, or for-profits out to grab as much Pell Grant money as possible, but it seems an awfully cynical answer when it comes to nonprofit education.

    …First, where the money hasn’t gone: instruction…

    …If current trends continue, the Department of Education estimates that by 2014 there will be more administrators than instructors at American four-year nonprofit colleges….

    Also,the reality is that universities and colleges are more in the business of fundraising for their multi-billion dollar endowments than education. That’s why you see so many more deans, provosts, BoT members, etc. not to mention the extra bureaucracy needed to back fundraising operations.

  6. Casey

    Depends what you subsidize – Consumption or Production

    Higher Ed consumption is subsidized.  So more people demand a limited good and price rises.

    Corn production is subsidized.  So suppliers over-produce relative to demand and the price falls.

  7. Tom Lindholtz

    In addition to SC’ summary, college is a labor intensive product and corn is not. The marginal increase in a farmers earnings contribute virtually nothing to each unit of consumption. But, for all practical purposes, in higher ed labor is nearly the entire bill, whether of professor, administrator, or staff. And the ratio of labor inputs to student consumers is relatively fixed in a traditional educational system. So as pay levels increase, often absurdly, there is nowhere else for student costs to go but up.

  8. Lucy Pevensie

    By the way, there is an entirely analogous process occurring in the area of adoption, where the government gives tax credits (not deductions but credits, ie subsidies) to people who adopt whose incomes are below a certain amount. The cost of adoption has risen, and since the subsidy takes the form of a tax credit, the cost is borne by the taxpayer and by adoptive parents whose incomes exceed the maximum allowable for the credit. It astonishes me how few people seem to understand this relationship.

    There’s a really interesting vicious circle in the adoption world. Because it is entirely illegal for any of that extra money going into the adoption process to get to the parents giving up the child, all of the extra money goes to adoption agencies and other service providers.  There is an increasing incentive for crooked people to become adoption providers, because there is so much money to be made. Activists then realize that there are crooked adoption providers and push for greater regulation in the adoption world, which drives up the cost of adoption further. Then adoptive parents push for the tax credit to be increased. And around we go.

  9. HoosierDaddy

    Comment #12 hit on the key component of why subsidies to *students* raises tuition – - – pain. The supply of places at prestigious colleges is finite. The price (cost of attendance) will always be raised until it becomes too painful for desirable students’ families to bear. In simple terms, colleges charge what they can, and there is no competition due to finite supply and barriers to entering the market as a supplier. Subsidies to students lessen the pain, so tuition goes up, restoring the equilibrium.

    If my hypothesis is correct, the same students would be attending the same colleges as now even if there were no subsidies. Please note that I’m speaking of ‘desirable students.’  Due to political correctness, colleges desire a substantial population of ‘poor’ students, so they give them tuition discounts. I don’t call that a subsidy.

  10. HoosierDaddy
    Scott Reusser: Subsidizing the cost of college allows colleges to charge more, so they do. · 10 hours ago

    This is making the same point, I think.

  11. Casey
    Tom Lindholtz: In addition to SC’ summary, college is a labor intensive product and corn is not. The marginal increase in a farmers earnings contribute virtually nothing to each unit of consumption. But, for all practical purposes, in higher ed labor is nearly the entire bill, whether of professor, administrator, or staff. And the ratio of labor inputs to student consumers is relatively fixed in a traditional educational system. So as pay levels increase, often absurdly, there is nowhere else for student costs to go but up. · 3 minutes ago

    Actually, pay levels/new dorms/rec centers etc have been a response to the influx of cash.

    If College A can get a market price of $X to fill one spot then they charge $X.  If I offer $1000 to help that student that actually does nothing to the market price.  The school knows they can still get market price $X from the student and my $1000.

    That extra $1000 is what gets sloshed around on the fancy stuff.

  12. Scott R

    Subsidizing the cost of college allows colleges to charge more, so they do.

  13. FreeWifiDuringSermon
    Schrodinger’s Cat: Your corn comparison is inapt.

    What the government subsidies in education are doing is the equivalent to the government giving subsidies to grocery shoppers to buy products which use corn. Demand increases causing price increases.

    Currently, the Feds subsidize corn growers (producers), while in education, the Feds subsidize consumers (students). Subsidize producers prices stay low, subsidize consumers prices go up. · 2 hours ago

    You’re right! So we should cut all gov’t backed student loans and just put that money into the colleges themselves? I know, not what you meant. 

  14. Jerry Broaddus

    Loans and grants provide insulation for the pain of high prices. Loans defer that pain and dilute it to a dull throb. Grants transfer the pain to others. But the point is that at the point of sale, the buyer, the student or the student’s parent, feels less pain than he should when buying the service. 

    This is exactly the same mechanism that has caused medical care to cost so much.

  15. Jeff

    It’s a third party payer problem not a subsidy problem.

  16. R. Craigen

    Simple principle:  Whatever you subsidize you get more of.  Or whatever you reward.  These subsidies reward expensive education.  Make it more expensive, and the government figures out how to subsidize it deeper.  It’s just a reward-response cycle.

    As for the mechanism, that’s a bit more mysterious but I saw it in action while teaching at a university in California.  The beancounters said we were going to run out of money in a couple of years if we didn’t improve revenue.  

    How to improve revenue?  We needed higher enrolment.  

    How to raise enrolment?  Here’s where it gets tricky:  raise tuition.

    How does raising tuition increase enrolment, you ask?  Simple.  Student enrolment was determined by how many applicants could get a Cal Grant.  How are Cal grants awarded?  By need.  How is “need” calculated?  By comparing tuition against family income.

    Problem was, our tuition (around $10K/yr) was too inexpensive.  Too many families could afford it, by the formula.  So they didn’t get Cal grants.  Increase tuition, and you increase the number who get Cal grants.

    They increased tuition.  Enrolment immediately went up, and so did revenues.

    It’s simple. 

  17. Skyler

    You also missed that corn syrup is subsidized, but also cane sugar importation is heavily taxed.

  18. Fred Cole

    I had a long answer, but this one is better:

    You cannot do economically unsustainable things in the long term, that’s why they’re unsustainable.  

    There’s a thing called Herb Stein’s law:  If a thing is unsustainable, it’ll eventually end.

    Subsidies make economically unsustainable things possible.  They break the normal rules of economics.

    When you do that, when you break the rules of economics like that, bad things happen.

  19. Roberto
    R. Craigen: It’s simple.  · 27 minutes ago

    If by simple you mean diabolical, it is simple indeed. Mr. Craigen. 

  20. Casey

    That’s fascinating, Craigen. Now can you explain how my wife buying twice as much at 40% off saves me money?

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