The Economics of College: Why Costs Are Rising and How to Bring Them Back Down

Education costs continue to rise, at a quick pace, despite the recession. In 2008, the cost of college tuitions increased again, at an annualized rate of 6-7% according to a recent College Board Study; even though during this period the CPI fell 2.9%. For striking visual comparison, see this graph of college, medical, and living costs. Costs since 1978 have increased ten-fold while medical costs have only tripled. We have an education crisis!

Let’s go back two hundred years to the year 1810. The annual tuition at Yale University was $33 [1], and the price stayed the same till the year 1852. Forty-two years with no cost increase! To put that in perspective with today’s money, $33 was equal to 1.65 ounces of gold, which today is about $1,800 dollars. Even after adjusting for inflation, today, the tuition is twenty times as high at $36,500.[2] Something is distorting the market significantly.

The cost of goods are dependent on the cost of production, supply and demand, and the amount of money chasing those goods.

With all the advances in technology, the cost to train students has decreased. Particularly, computers have revolutionized college; making record keeping and grading student work much more efficient. The internet has enabled distance learning to become a popular and efficient way of obtaining degrees. Additionally, more students are going to college, which creates economies of scale (The cost per student is lower, the more there are). The cost of training students is not the factor contributing to increasing college costs, it is actually decreasing them.

How about the supply and demand for college? Demand has increased greatly, as more and more people are finding a high school diploma is insufficient. The supply of colleges are also rising; in the past 60 years, it has nearly tripled from 1,851 degree-granting institutions in 1949 to over 4,300 in the year 2007 [3]. Since supply and demand are generally increasing together, their influence on the cost of college is insignificant.

Finally, let’s consider how much money is chasing the college tuition. Absent a government guarantee on student loans, no one would lend students money to go to college. The risks would simply be too high. However, with government backed student loans, lending money to students is really no different than buying a treasury bond. There is no losses for the creditor, thus eliminating all the risk in lending to students. Additionally, there are many types of grants, which increase the pool of money further. Since students have access to all this money, more money is chasing the same amount of goods (college educations). Prices are bid up as students compete to get accepted.

Who is really profiting from these government student loans? Not the students. They are the ones stuck with the bill- often for two or three decades! Universities and colleges, on the other hand, benefit tremendously- they can raise prices without losing business. There is no incentive for them to cut costs and become more efficient. If a student complains about the cost he can be told to get bigger loans.

The solution is for the government to stop subsidizing student loans. How then could students afford the horrendous costs of college? Universities would not sit empty- prices would plunge. Suddenly they would be forced to cut overhead costs and become efficient. All the excesses would finally be reined in. Less money chasing the same amount of goods results in lower prices. This is real reform that simply restores a free market- which helps the poor and the middle class and stops subsidizing the rich.

If the free market in education was healthy, we would be seeing significant improvement in quality, access, and cost. Unfortunately, government involvement has caused the opposite. The same issue is making other goods more expensive- health care, food, and housing. These rising costs have impacted the poor and the middle class greatly, while benefiting universities, bankers, insurance companies, and food giants. The free market always delivers better results- if you let it.