Differential Pricing in University Education

Traditionally universities have charged every student the same tuition/price regardless of major. Under budget pressure, however, differential pricing is becoming more common. Differential pricing is tending to reduce the peculiar cross-subsidies that currently exist as pointed out in a new working paper by Kevin Stange (earlier version):

Higher education in the United States is heavily subsidized, both through direct support for institutions by state governments and private donors, and through federal and state support
directly to students. There are also substantial differences in the extent of subsidization across
institutions and sectors, with students at selective private institutions more heavily subsidized
than those at less selective institutions(Winston 1999). Less commonly noticed, however, is that
there are also large cross-subsidies between students within the same institutions due to the
conventional practice of charging similar tuition fees to all undergraduate students regardless of
the cost of instructing them. The cost of instruction differs tremendously between upper and
lower division coursework and across programs even within institutions. For instance, recent
analysis of cost data from four large state post-secondary systems (Florida, Illinois, New York‐
SUNY, and Ohio) indicated that upper division instruction costs approximately 40% more per
credit hour than lower division instruction, and that upper-division engineering, physical science,
and visual/performing art was approximately 40% more costly than the least costly majors
(SHEEO, 2010). In fact, an earlier but more extensive cost study found that more than three-fourths of the variance in instructional cost across institutions is explained by the disciplinary
mix within an institution (U.S. Department of Education 2003). The consequence is that lower division students subsidize upper-division students and students in costly majors are subsidized
by those in less expensive ones.

This pattern of cross-subsidization generally runs counter to differences in post-schooling
earnings and ability to pay. Lower division includes many students who eventually drop out,
while students that have advanced to upper division are more likely to graduate and earn more.
Engineering, science, and business majors tend to earn more and have higher returns than
education and humanities majors, even after controlling for differential selection of major by
ability (Arcidiacono 2004).

I have argued for targeting education subsidies to the majors that are most likely to have the greatest positive spillovers. Differential pricing moves prices closer to costs which opens up the possibility for more rational pricing but notice that it can in some cases move prices away from optimal subsidy levels.

Hat tip: Dubner at Freakonomics.


"majors that are most likely to have the greatest positive spillovers": is that a reference to the possibility that education might, in part, be a public good?

Possibly, but I'd guess that its mostly a private good. And, no doubt, some of the public good aspect will actually be a negative public good.

"greatest possible spillover" is an invitation to political nonsense. After all, every woman's studies department will argue that it has amazing social benefits, and we all know about the awesome contributions to mankind made by "social justice" majors (or at least their profs and deans will so argue).

OTOH, the usual suspects will argue that engineering and serious STEM majors are corporate drones with no useful spillover whatsoever.

And if you think "useful spillover effects" are going to be decided rationally instead of who wins a PC rhetorical/power game, I've got a Ivy undergrad admissions committee seat to sell you next to the Brooklyn Bridge.

While I don't share Foobarista's particular preferences this critique of the OP is dead right, as I argue below. People need to read their Hayek.

You can reduce cross subsidization by eliminating tenure. Tenure has become a drag on universities ever since age discrimination statutes prohibited terminating elder faculty members.

As I have mentioned before, my next door neighbor, a retired Dean, said he would have liked to have created a Chinese language program, but he had to keep on the Italian and French language profs who no longer had sufficient students to justify their retention.

Reduce intra-university cross subsidization to free up money for other courses.

Ah, my question from the other day is why they like to weed out their customers. Now I know. Case closed.

Isn't the US also one of the most expensive (as fees) higher-ed nations in the world? Funny that it is highly subsidized and most expensive both at once.

Fox Butterfield, is that you?

Weird, huh?

It's almost like higher-ed is supply-limited, so the extra subsidy dollars are just creating price increases instead of supply increases...

Wow. So now in addition to making science and engineering majors work harder than the others to get the same or, more typically, worse grades and class placement and honors than they would elsewhere (with no indication of that given to employers), we're also going to make them pay more for the privilege. (And then should they decide to continue in research, keep their salaries below $40k until they're 35). This country has really got it all figured out.

My read is the exact opposite. STEM degrees would be less expensive because they produce more spillover effects. This would also incent dropouts to stick with it.

"Traditionally universities have charged every student the same tuition/price regardless of major."

In terms of sticker price, sure. However, I was under the impression it has been long since established that universities do a good job on price discrimination for incoming students via financial aid packages; is there any literature on whether declared major might be one of the factors affecting how flexible universities are on price for prospective students?

Interesting question. My understanding is also that financial aid is designed to extract as much cash as it possibly can and that the only important thing about the sticker price is that it be higher than the vast majority of students can afford to pay.

But it strikes me that declared major for the entering class may be so unreliable as to not be useful in this research.

Isn't most US-financial-aid agnostic to major-choice? If true, that seems a big policy blunder right there.

And if at all that is going to compensate by biasing enrollment towards "easy" majors.

Formally speaking, yes - I know my University offered some scholarships to specific majors/schools (oftentimes that were funded by a grant specified to that purpose), but most financial assistance (of both the need and merit-based varieties) did not ask for information on your major.

My curiosity, however, was whether this holds true in practice. A strong business or engineering student was much, much more valuable to my University than a comparably strong history student (both as a near-term fundraising propr and as a long-term donor prospect); since it seems pretty commonly accepted that financial assistance packages are tailored to attract the most valuable students, it would stand to reason that there would be some effort to discriminate by major.

Don't give them any ideas. They'll just try to extract more money from the STEM majors after graduation.

"Oh, you are three million in debt? Well, good news! Pay 20% of your salary for 25 years and we will forgive everything!"

The sick thing is some people think this would be a better state of affairs.

Wouldn't this encourage people going to less needed majors?

Exactly what I was thinking. Do we, as a nation, really want to end up with more history, English Lit. and women's-studies majors?

Isn't there an incentives argument here?

Wouldn't libertarians let students make up their own minds about what to study?

This whole discussion, from the OP on down, is very strange. Alex Tabarrok and his merry band have become state planners! You're pulling a public "need" or "positive spillover" out of the air and manipulating prices to make people do what *you* think they ought to do.

I don't know about "we, as a nation", but for me, as a software guy, I love the idea of more English lit and womyn's studies majors: More money for me and more interesting conversation while waiting for my coffee at Starbucks.

My undergraduate university had 7 "colleges" (STEM, humanities, architecture, agriculture/biology, style/design, and pre-business/law). Each had their own admission processes and administration, but the same tuition rates across all. I always wondered why the tuition rates weren't different for each college.

I will bet those art history majors are pretty cheap to produce, so the road to national prosperity is bound to be replacing those darn expensive chemical engineers with them.


Physicians, I bet those ones are even more expensive to train.

Typo alert!

It's Kevin Stange, not Strange. I bet he gets that a lot.

People are missing Alex's point that the Feds and state's interest is in subsidizing the spillover effects. I'm fine with engineering education costing more, partly because of the opportunity cost of engineering professors, with the greater reward on the back end, which can be financed easily.

Yea, I think most commentators here are taking the wrong message. The point isn't that we should reduce cross-subsidization, it's that cross-subsidization just happens to conform exactly with the incentives that society probably wants to promote. We're effectively taking money from those that are (arguably) less likely to generate spillovers and giving it to those that are more likely, but it just so happens that this subsidy is exactly balancing out the cost differential.

Also, as we know, science brings in students who then switch to other departments. Also, STEM upper classmen become the graduate students that bring in the grants that cross-subsidize. A full accounting would be interesting. It is also interesting what motivates this now.

" it just so happens that this subsidy is exactly balancing out the cost differential"

It doesn't always work out so neatly. One of the most expensive undergrad majors (from the university's standpoint) is theater/performing arts.

Even if there are more positive externalities from STEM than other majors, that's no reason for the history or poli sci majors specifically to be subsidizing the EE major.

It'd certainly be possible to have differential course prices based on cost, combined with more generous merit-based scholarship offers for those who do well in the STEM fields. Unless we think non-STEM majors have negative externalities, in which case I guess we need to start taxing them.

As true as saying that people insuring against emergency conditions have no reason to subsidize those with chronic medical issues. Except that it probably evolved that way since they use the same hospital, or campus in the case of the university.

Even if there are more positive externalities from STEM than other majors, that’s no reason for the history or poli sci majors specifically to be subsidizing the EE major.

Are we examining for each department just cost, or also revenue? There's much grumbling in the STEM departments I'm familiar with about the percentage of overhead skimmed off by the university from various sources of outside revenue.

However, that revenue does tend to be a bit separate from teaching. Perhaps the right change in policy would enable departments to get away from all that unprofitable teaching entirely, and focus entirely on successful grant application writing.

Don't the grants simply subsidize part of the costs of the research? More grants are made available for some areas precisely because the research costs are so much higher. Hopefully, grant availability also takes into account social benefit, but the 'value' of the research is probably decided by insiders in that area, so it's hard to tell.
I'm in a business school, which brings in little outside grant money, but our research doesn't cost much and we teach students that pay a lot, at least at the MBA level.

In the conventional liberal-arts model, your "major" is only a part of your overall education -- sometimes just 1/4 of total courses -- and everyone benefits from intermingling: you want your lit majors taking lab science and your botanists learning art history. You also want people free to switch majors, which many students do and which is arguably a good thing.

The opposite extreme is the European model where you enter your "major" and do nothing else. It does seem to me that as you move toward that model (and U.S. STEM degrees tend to up requirements so that "their" students take little else) the argument for the cross-subsidy weakens.

From my perch at a State U, there is no question that fields which just need a room and an instructor (e.g. psychology, history, lit) and whose instructors are not expensive, cross-subsidize fields that need labs or studios (e.g. lab science, art) and/or fields where teaching talent costs more (e.g. accounting).

And no, grant overheads don't make up the difference. In general the units that get the grants keep the overhead. People who get grants like to believe that the whole university is living on their dime, but they won't actually run the numbers.

What university is he talking about?? Practically every modestly selective institution in the US practices rampant price discrimination, based on academic ability. The sticker price is nearly irrelevant - you only pay that if you're a mediocre student from a rich family who was lucky to get accepted. Everyone else gets a deal, personally tailored to them by dada-mining software. If this is imperfectly percieved by potential students, that generates some interesting dynamics... but I don't think that's his point.

dada-mining software

This is not a typo. You should see the stuff.

> Everybody gets a deal

Only to a point. If you have enough wealth or income (especially if the child has wealth in his or her name), then you pay full the full price, even if the child is brilliant. Think of it as an tax system instead of a tuition charge.

Something is fishy with this result: it only holds if you ignore the subsidy between research and teaching. Since grant overhead is flat rate at a university--day 55% as a modest number. The science and engineering finance the all of the amenities at the university because grants are tiny in English and history. Tuition income is nearly rounding error for these schools.

Moreover... In my experience engineering classes were large--many students per instructor. Literature classes were small.

The net of this: in economics having a TA was hard abd course money was tight. In engineering the classes the opposite was true.

There are teaching universities and research universities (both STEM and liberal arts) and increasingly teaching is, I think, considered a crass trade. I'd bet this is in part because this isn't where the money is. Money from grants and from alumni is pretty big. It might well be comparable to newspapers (if you remember those) charging for subscriptions but really making their money off advertising -- to the degree that many paper papers these days charge pennies for a subscription just so they can prove to their advertisers that they have a huge circulation to justify ad rates.
It's more complicated than "engineering profs are dearer than literature profs".

On a general note, I was all on the STEM bandwagon a few years ago, but now I'm seeing black helicopters. If we move to a nation that federally subsidizes our higher education program in order to encourage science and tech, that sounds nice and progressive, doesn't it? But considering most public schooled kids these days get nearly no literature or history education before college (it went out with cursive), we are rapidly moving towards a kind of spooky scenario. The federal government actively encouraging the entire population to have nearly no historical frame of reference for anything they do. An American "elite" with absolutely no exposure to thought other than the technical and scientific is going to be a very handy and usable tool. I know folks today who are fairly competent in tech fields but have no understanding of, for example, basic logic. They are very easy to fool. I'm not sure I want a lot of people around who can manipulate nanotechnology and are easily fooled by politicians and bureaucrats.

I frankly can't see why moving the government entirely out of education subsidies (both tuition and research) wouldn't be an excellent idea, promote better science, and drop the price of tuition by at least half.

Me too. I have one prescription for STEM. Make it easier. Maybe we don't even have to do that. Maybe all that is needed is to have two parallel GPAs. The major GPA and the normalized GPA that corrects for the difference between the GPA of STEM majors and non-stem majors.

Conversely, you could make non-STEM fields harder again. . . .

The trouble is that in an effort to avoid making value judgements, non-STEM professors/departments just assign more busywork and grade to a rubric. When I was an undergraduate, two upper-division polisci classes I took the same year had vastly different final projects. One prof told each of us to set our project's topic and length, and challenged us to impress him. The other prof required 25 single-spaced pages.

Of the two approaches, I know which I expect will train independent-minded scholars.

re: normalized GPA. I think then you'd run the risk of students just trying to be in the class for the GPA multiplier. We had something like that in my high school and it encouraged some to take classes they shouldn't be taking just to get the multiplier.

No, traditionally (especially the last 30-40 years) Universities HAVE had differential pricing: Higher Quality students receive steep discounts, lower socioeconomic groups receive some discounts, those in the middle usually pay sticker price.

A key metric in the world of Higher Ed is a school's "discount rate", or the average by which they discount the sticker price for students. For publics, this is usually around 5% to 12%. For privates, this is usually from 30% to 45%.

On top of this, it is not uncommon for schools to charge, for example, science majors, about 3% to 5% more.

Regarding intra-institutional subsidies of courses, lower level courses typically subsidize higher level courses. This is mostly an economy of scale effect: Students take similar lower level courses, but widely divergent higher level courses.

If greater spillovers are correlated with higher private returns, then is there a marginal externality? I am referring to the Buchanan-Stubblebine (1962) distinction between infra marginal externalities and marginal externalities. Only the latter "require" subsidization.

With high private returns, students may be, adjusting for risk, etc., driving marginal external benefits to zero.

(This is separate from the issue of whether tuition should reflect the costs of giving different kinds of education.)

It doesn't account for the 40% difference that the paper claims but U. Michigan does charge different tuitions for different colleges and different tuitions for upper and lower division students (roughly first two years vs second two).

Engineering tuition ($6,933/$8,987)
Literature, Arts, and Sciences tuition ($6,474/$7,309)

Thanks for putting specific numbers to what I have seen when looking at getting degrees in different areas of interest, and when looking just to take different classes. Taking a course has meaning only to yourself and those who know the department, so I looked at degrees and certificates which then involve paying a variety of prices for the same numbers of credits.

Courses are priced like airline tickets, the basic fare, the taxes, the boarding fee, the baggage fees and you are required to carry three bags for some destinations, with special fares for frequent flyers and for those traveling standby, With the option of buying a month or year pass which covers the fare, but not all the other fees. And snacks are extra and you can bring your own, but they must meet the approval of the pilot.

It seems to me anyone talking about college costs needs to go back and pay for college as part of their research, actually taking all the courses and attending classes and labs for four years before saying anything about the costs. Lots of college administrators and instructors have no clue about the total cost, but other know exactly what the costs are and works to cut your costs by explaining the yield management system, and how to get the special fare, and buy picking textbooks that are priced at cost, not for publisher profits.

"I have argued for targeting education subsidies to the majors that are most likely to have the greatest positive spillovers.
- See more at: http://marginalrevolution.com/marginalrevolution/2013/07/differential-pricing-in-university-education.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+marginalrevolution%2Ffeed+%28Marginal+Revolution%29#sthash.GogXRPvE.dpuf"

What exactly is special about education that it's not correctly priced in a unsubsidized competitive market setting? Also, why should government be any better are correctly identifying the majors to subsidize for maximum spillover that they ever have been for economic spillover via industrial planning subsidies?

So what would happen if you eliminated the FAFSA?

With its power to ask every customer "How much money do you have to spend," higher ed. gets away with more price discrimination than is possible anywhere else.

That's supposed to be a feature, not a bug. Is it?

Ok, I'm curious what kinds of numbers Alex things would result from differential pricing and/or differential subsidies.

Just saw a segment on NBR where a Siemens subsidiary in NC was expanding its manufacturing but could not find qualified factory workers. So it partnered with a local community college to bring in the German training program, implementing the German apprentice training system. The stated cost per student was $170,000 which from my investigation is roughly two years college level work. Siemens and the college split the cost, and the college probably splits the cost with students and government in State subsidies, grants, with Federal stimulus grants to community colleges for manufacturing education.

Should liberal arts majors going on to a State college or university after two years pay higher tuition to help pay for the manufacturing majors, or should they simply pay full cost of instructors and overhead, while all the government subsidies get targeted at the manufacturing major so the cost of a manufacturing two year major is the same as two years of liberal arts at the community college? I'm sure full freight two years liberal arts at a community college for transfer is a lot less than $170,000.

Australia has different prices and public subsidies by discipline. Generally, shifts in relative prices to students have not lead to shifts in demand. However, a big increase in the subsidy for science courses and consequent drop in student prices did coincide with a large increase in demand. Complicating the story, however, demand kept increasing when the price was put back up to the earlier levels in 2013.

I find this very interesting. I am a current college student and this post in a way has largely increased my understanding of our higher education system and our highly subsidized tuition. I always wondered why tuitiom was the same price for every student while it was clear that some programs are way more costlier than others. It makes sense to take money from lets say a dance major, and transfer it to the curriculum of a physics major. It is true that there is a positive spillover effect. Eventually the physics major will contribute more to the economy than a dance major.

Eh? The studies that cost more to teach (such as STEM), lead to better job prospects and higher wages (with the exception of performing arts perhaps). So we should charge more for them (the education costs more AND they will earn more), no? That's differential pricing: things that cost more to provide should have higher price tags, and things that are more valuable should cost more.

But that's not the argument it seems the author(s) want to make: they want less tuition charged for those degrees that are more expensive to teach (a.o. STEM degrees) in stead of more. That is a sound argument if you base it on the economy as a whole, because you'ld want to subsidize degrees that are more valuable. But it is counter to the idea that tuition should reflect actual cost.

Great post.

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