the happy conservative

While I’m avoiding the 2×2 Heckscher-Ohlin model.

The next time you hear about how schools are underfunded, consider how that money affects the student population.

Let’s say the government decides to increase funding for student grants. Great idea, guys. A couple of things happen.

At schools where enrollment is capped (like Washington U.) by factors other than money, school is cheaper for low-income students. More grants subsidize (very) low-income students. But the students don’t keep the money. Nope, every dime goes to WashU, some of it for teachers, some for buildings, some for Student Union to bring Paul Begala to speak.

Let’s step back for a moment and consider how WashU decides what to charge for tuition. It has nothing to do with allocating a scarce resource, because the price of tuition isn’t high enough to eliminate the queue. Tuition has nothing to do with marginal cost, which isn’t really surprising. So what keeps the price of tuition as low as it is? Perceptions. What should tuition cost? It’s politically unpopular to allocate seats at prestigious top twelve universities based on willingness to pay. We have to keep the costs low enough that low-income students have the same opportunities as high income students. It’s only fair.

Cue the increase in federal spending. Now what? Tuition just became more affordable for students. Thank goodness! But it also just became less costly for colleges to raise tuition. Why? Because the increase in federal grants has made it possible for colleges to increase student costs without alienating people based on wealth. They can raise prices without losing student base.

Increasing the federal grants leads to an increase in revenue for colleges. Low-income students are precisely as likely to go to a prestigious school as they were before, and every student who wasn’t receiving federal assistance now has a tuition increase to deal with.

Great. Let’s spend more on education.

(To be completely correct, the incidence of the subsidy depends on the relative elasticities. Since the present equilibrium isn’t competitive anyway, it’s not particularly important for this example. The university is going to get all the money. Yippee.)