Rising Tuition Rates?

[I love hearing from Greg about how economics explains things that are happening in everyday life, so I asked him to guest post! Greg has a knack for explaining things in a simple way that make sense. This is his first blog post and I think it is very interesting - enjoy!]

You have probably heard that college tuition rates have risen dramatically over the past 10-15 years. This is correct. In fact from 2001 to 2011 rates have risen by over 60%. The problem though is that these facts don't tell the whole story - there is a very interesting story behind these raising rates. A closer look proves that, while tuition rates are rising, the amount that students actually pay is increasing at the same rate as inflation. So, how is this all possible?

The first reason is something called price discrimination. You may have heard this term from Econ 110. This is when businesses charge different rates to different people for the same product. Some examples are student or senior rates at the movies. Another example is airline tickets. Depending on how busy a flight is, or how desperate a flyer is (determined by how recently they bought a ticket) the price of a ticket fluctuates a lot. Most colleges do this too. Take the case of Harvard. Harvard's tuition for one year of school is about $40,000. The great thing about Harvard is they offer a very "generous" financial aid program for their students. They request the information regarding the incomes of each of the student's parents, and offer scholarships depending on the income level. The richest of students pay the full $40,000, less wealthy get perhaps a $10,000 scholarship, even less wealthy get a $20,000 scholarship and so on until the actual price of the tuition equals what it costs Harvard to provide it to that student. I have no idea what that would be. But basically what they have pulled off is some of the best price discrimination out there. They charge people very close to what they are able to afford, and make a killing.

Harvard has been doing this for a very long time, and other schools are starting to catch on. More and more school are shifting to this type of system of having very high tuition rates, which only a small portion of students pay, and offering a very "generous" financial aid program. What does this translate into? A 60% growth in tuition rates (the sticker price that few actually pay) but the growth of actual payments made by students growing at about the rate of inflation (2 percent a year).

I could end here, but there are two other reasons why universities love posting high tuition rates that get marked down with financial aid scholarships. Reason number two follows a similar strategy used by clothing stores. You are looking for a pair of pants, you find a pair that is $30, and another pair that was originally listed at $50, but is on sale for $30. From what you can tell, they look about the same (and the stores little secret is that they are), but hey, how could you pass up the $50 pair that's on sale?! This is the same marketing strategy that colleges are favoring. A high tuition seems to announce, "We're a good school." If you were accepted to a school that is $10,000 a year, and to a school that is $30,000 a year but you get a $20,000 scholarship, I would predict you would choose that latter.

The last reason (that I can think of) is the proud mom effect. Moms love to brag about their children, and does it get any better than her child getting a scholarship at Harvard? Probably not. People feel proud about getting scholarships, so even though everyone else might be getting one too, opening that letter and seeing how much they are going to take off your tuition is a great feeling, and certainly brag-worthy for moms.

To sum it all up, the sticker prices of colleges and universities are rising at a very rapid rate, but this should not be alarming unless you are very rich and can afford the high rates. Everyone else's tuition is staying right where it should, and if you're poor it's actually decreasing. Schools are just using price discrimination to suck the profits out of the rich kids (which I am fine with by the way), and offering discounts to make their school seem more appealing. Receiving that scholarship also makes us feel good.

Now you know the truth when you hear politicians make claims about how students are in dire need of help to stave off evil schools that are charging way too much .

What do you think is going on with these rates?