Sunday, July 14, 2013

Economics and morality of price discrimination in college tuition Part 2

...Continued from the first post
Survive or die.  Capitalism wins the day
Seems harsh, but this happens in all markets, and educated labor markets are no different: employers will only look to hire and use however much they need.  Similarly, if products fail to adapt with the times, then they must either adapt or be forgotten.  In this case, a couple of majors may not survive if they continue to be priced the same way as in-demand degrees.  This creates educational arbitrage and universities do not have to take responsibility for it since they are the only institutions that offer creditable degree programs. And thus we have huge market gaps.

One example is fields or majors that are overpopulated with qualified individuals.  If there's a shortage, like there is with programmers and engineers, then wages are going to be attractive and there will be plenty of opportunities available to those who are willing to brave the choppy waters of said fields.  However if there's an overage of qualified people in certain fields, such as in law or psychology, then there will naturally be fewer jobs available for the wages they would want.  Although there would be pressure on employers to drive down wages, they can't because education costs are high enough as is and graduates want to be compensated adequately for the heavy investments they make.

Wait, What if we....
Do away with college altogether?  It's gotta be a scam right?  All joking aside, there should be a more tangible solution.  Markets may dictate availability and wages of jobs given the demand, but universities' collective role in producing the next generation of professionals can and should be altered.  If universities treat all majors the same and charge a flat rate, they aren't maximizing their return on investment for each student in the long run.   Eventually students and future applicants will opt to apply for the more profitable degree programs and when those get overpopulated, they get turned away and take their talents into other fields away from universities.  Instead of settling for underemployment after college, they'll cut out the middle man and maximize their earnings potential without debt even if it is lower than what they hoped for.  It's a dark reality but also a possible one.
Universities argue that they address these disparities via financial aid and wealthy donors;  however, this strategy is inefficient because it depends on factors largely outside of most students' control (parental income, tax returns, government's willingness to fund, private sector's willingness to fund, etc.).  Most of the time, the aid students receive is akin to a loan albeit at a higher interest rate either collecting interest during school or after graduation.  In the long run, universities won't maximize their investments because they will have to do away with some of their art institutes, lose some donor funding, and see a huge flock of people being turned away because there will be too much demand for their top profiting degree programs.

So why not charge different prices for different majors? An art history major will likely not make as much as a programmer anyway, so why are they charged as though they will? This is more in line with rational investment decisions because a person who realizes that his returns on investment are the same percentage no matter what route he chooses, will opt for the one he likes the most as opposed to simply the one that makes more money.

I've mentioned return on investment a lot, but how would a university set up a price discriminating system to eliminate "educational arbitrage" and maximize their future earnings from students.  I'm not sorry about using math.

  • Evaluate the mean annual starting salary for graduates from the university for every major.  I_philosophy = 30,000  I_civ.eng. = 70,000.  Numbers are hypothetical
  • Evaluate the unemployment rate for each major.  Subtract this value from 1 and multiply that number by the mean salary of graduates.  u_phil =.2.  E(I_phil.) = (1-u)*I =24,000.  u_mech.eng. = .05.  E(I_civ.eng) = (1-u)*I_civ.eng = 66500.
  • Multiply this expected value by some coefficient correlated with the relative rankings of the university and a discounted value of future education required.  For instance a philosophy major or a law major needs more school to get a job so the university should factor that in and create a pricing scheme.
This method is far from perfect but merely a sample of how one would go about price discriminated based on earnings potential. There are other factors associated with this which I have probably not thought about or addressed.

But why should we conform to them? We hold all the information.   
There are some ethical questions behind this.  As I pointed out earlier, universities could easily fall behind the 'we're a learning institution, not responsible for the salaries and job prospects of our students' tag. After all universities have their own interests to protect whether it's maintaining buildings, hiring top quality professors, offering tenure, or attracting generations of applicants or future donors, and protecting their prestige.  What goes on in the corporate world shouldn't bother them because they don't offer half of those things. That too, universities would even argue that they are more valuable than corporations because they're the intermediate step between young adulthood and adulthood.

There are several ethical concerns about how much higher education should be determined by what's popular in the private market since often times their interests are at odds with each other. But my argument is that from an economical point of view, universities should offer variable rates on their tuition fees based on earnings potential from the majors students choose.  Not only does this allow students to make a more informed decision on following their passion but it also gives them more liability.  Survive or die isn't going to be thrust open them, but rather presented to them so they can make a rational choice.  

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