The Economics of College Predation

Over the past thirty years colleges (and schools in general) have raised the cost of attendance, massively.  As Seth Godin points out this is clearly unsustainable.  It also (as I have pointed out) is tantamount to piracy.  To put it "charitably" charities that constantly raise the price for the same service are not behaving in a 'charitable' manner.  But this is an outrage that is well known, if not adequately protested.

What is less well know is how these institutions use monopolistic pricing methods to wring every last dollar out of their vulnerable young charges.  Indeed, how they use tactics that are illegal in almost every other setting than education.

Reach back for a minute to your college Microeconomics.  In a perfect competitive market, Supply and Demand curves intersect at a market clearing price and volume for a given commodity.  In any market there are large numbers of customers who derive far more value from the commodity than the price they paid ( a good example here is toilet paper).  This is represented by the blue triangle below.

This is called the consumer value surplus or the surplus caused by there being a single market clearing price.

Monopolists covet this consumer surplus for their own.  Monopolists seek to charge each consumer the maximum price they will pay - in other words they seek to "Price Discriminate" on the basis of ability and willingness to pay - charging a small price to those who can only pay a little and a huge price to those that can pay a lot.  The key is to get every single customer above the marginal cost to pay the maximum amount they can, which is the full amount of the value they derive from the commodity.  The problem for Monopolists is that they don't know exactly what each consumer's value function is for their commodity - does this customer look poor but have millions?  So they try to discriminate but often fail and still deliver quite a bit of consumer value surplus in spite of themselves.  Nonetheless, in most of America this form of monopolistic behavior is called a "crime".  One that will get the CEO of the guilty party 5 to 10 in Club 'Fed'.

Except in educational 'charities' like colleges and private schools.  In the education market not only is it legal to price discriminate it is considered positively righteous to do so.  And remarkably, schools have persuaded consumers of their service to tell them in advance precisely how much money they are willing and able to pay for the service - a Monopolists's dream.

How do educational 'charities' persuade otherwise rational consumers to give them the rope that they will hang them with?

First they deliberately set ridiculously high list prices.

Second, they require anyone unwilling or unable to pay the stratospheric prices to complete a brutally intrusive family financial statement that identifies every asset and income stream the student has at his disposal.

Armed with this complete data, they then calculate the precise amount that the student and his family can afford to pay and offer discounts (grants, scholarships) based upon 'need' or the difference between the high list price and that amount.

Then, if they're colleges, they offer federally funded loans based upon how much they judge the student and his parents will fall for in terms of future indebtedness for the poor student.  The list price less grants, scholarships and loans is that student's personal, monopoly price.

In this manner they are able to maximize their yield on every student able to pay above the marginal cost.  What about students who are unable to pay marginal cost?  Well that's where the "charity" comes in - the schools use their favored tax status to raise money to pay up to the marginal cost (and then stuff the vulnerable and inexperienced youngsters to the gills with federal loans that unlike credit card debt can't be repudiated in bankruptcy).

So they jack their rates up at three times general inflation, they price discriminate to ensure that every bit of consumer value delivered by their services is captured by them, leaving nothing on the table for their customers and they have the temerity to tell us that they are 'nobler' and 'more compassionate' than dirty, private businesses that don't price discriminate.

As I have said before, calling these monopolistic predators 'pirates' is an insult to the time honored profession of Piracy.

"Charities" indeed.