The Market for College Education

Note:   This is not a deeply researched post.  Mainly a thought experiment.

Micro-economics teaches that if there are lots of suppliers and customers for a specific good or service then we should expect the competition to improve the product over time.  The product may become cheaper or have better quality or both.  

One typical example is observable in digital technology - CPUs, memory, disk storage, data communication have all shown remarkable improvements over time.  The market I'd like to focus on is college education.    

There are lots of suppliers and lots of customers.   But over time the "product", education, has become more and more expensive in real, inflation adjusted terms.  Why?  Doesn't micro-economic theory predict lower prices and/or improved quality?

I'd like to compare this to the auto industry.  Let's look at the similarities.  In both cases there are lots of suppliers and lots of customers - so we have competition.  The consumer has lots of information about the product.   Cars have become cheaper and better.  It's hard to make a judgement about whether college education has become better.  It certainly has not become cheaper.

One other similarity.  There's not one market for cars and one market for college education.  There are lots of markets.  For cars there are markets for compact cars, family sedans, SUVs, pick-ups, luxury cars.  A Honda Civic does not compete with a Lexus or a Ford F-150.  But in all these submarkets the car manufacturers are producing better and/or cheaper products.

College education also has a number of submarkets.   The product of an elite school is an education and a credential.  The product of a large state university includes a broad array of services including expansive sports programs.  Small liberal arts college offer a more intimate educational experience.  Alabama does not compete with Harvard or with Amhearst.  The offer different "products".  But it's hard to argue that any of these submarkets are producing better and/or cheaper products.  Interesting to me is that there is one submarket that only sells education - community colleges.   No fancy dorms, not much of an athletic program, no extravagant library or student activity center - their product is essentially education.  

As an aside I started this thought experiment around a discussion of big-time college sports programs.  There's a nagging question as to why colleges pay huge salaries to their football and basketball coaches.  It turns out that these big-time programs are profitable, and the profits are used to subsidize other sports, e.g. women's field hockey, archery, etc.   Still the question is why do they spend any money on sports and the answer is that this is part of the "product" that large state universities sell.  They sell the "total college experience" including the option of competing in minor sports or attending exciting football and basketball games.

So we see similarities but what's different about this market.

One is that most colleges are non-profit.  This doesn't mean they don't make money.  Private non-profits have the same need to compete for paying customers as for-profit companies.  They need revenues to exceed expenses.  And, they do.  An extreme example is Princeton.  Revenues and unrealized capital gains exceeded expenses by $20 billion last year.   Of course, they pay no taxes.  What does Princeton do with money?  The answer is not much.   A for-profit business would probably use the money to expand their business, i.e. attract more customers.  Princeton doesn't care about that.  They are content to teach 8000 students each year. 

This suggests a second difference.  Barriers to competition.   Some schools like the Ivies don't compete for students they select students.   As long as revenues exceed expenses they lack the market-based incentives to innovate.  So supply is intentionally limited by the suppliers!  Kinda like OPEC.  Limit supply so that there is always sufficient demand to charge higher and higher tuition and fees.

The other barriers to competition may be (a) the obstacles for creating new accredited colleges, and (b) space limitations that prevent urban schools from expanding, e.g. NYU.  Not sure about this.  

The third difference is that the customers/students have access to the money needed to pay the increased costs via grants and federal and private student loans.  Students can borrow lots of money with little or no income, little or no credit history and no collateral.  Imagine someone in their early 20's with the same credit profile as a college student applying for a bank loan to start a small business.  No chance.  But students can borrow and borrow a lot.  This ties into the current debate on student loan forgiveness.  Colleges don't need innovations that reduce costs as long as there is an increasing amount of customers willing and able to pay higher and higher tuition and fees.