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Defining Cost and Price

By Lucie Lapovsky

Lucie Lapovsky is vice president for finance at Goucher College.

Lucie LapovskyTHE COST COMMISSION’S REPORT has clearly recognized the complexities of the cost issue for higher education and the confusion surrounding the use of the term “cost”.

The distinctions the commission has made in defining “cost” to mean at least four different things goes a long way in clarifying this term. The commission notes that cost can mean: production cost; sticker price (posted tuition and fee price); total cost of attendance (sticker price plus room, board, books, supplies, transportation, etc.), and net price (sticker price less financial aid).

These definitions often are used interchangeably, and this imprecision in our use of language tends to confuse the issues.

The production function for higher education involves the combination of labor and capital each college and university employs to provide education. The relationship of labor and capital in the production function has changed over time along with the market basket of goods demanded by educational consumers in traditional educational settings.

The production function for instruction as distinct from education has become significantly more capital-intensive in recent years with the addition of more instrumentation and technology per faculty member. The expectation that technology was going to increase productivity in higher education instruction has not been realized in the traditional institutions. As capital is added to the instruction function, increases in labor also are required.

Institutions without walls are achieving productivity increases with the new technologies and are operating on a very different production function from traditional institutions of higher education and from the traditional parts of institutions.

The increasing cost of production of traditional education is motivating many traditional institutions to diversify their product and offer more than one type of education using different models. The University of Phoenix is making many institutions reexamine their paradigms on the delivery of instruction and certainly is offering a no-frills model. This institution operates with minimal facilities, no libraries and no student services. It provides a product which appeals to many students and certainly offers an alternative production function for instruction.

A second component in the cost of producing education for the traditional institutions is the fact that the services students expect as a part of their education have grown significantly. Extensive counseling and health services, career development services and social programming supplied by the college are just a few of the services which have increased.

In addition, students’ expectations about the amenities of their physical environment have increased enormously. Voice mail, cable television and internet connections in residence hall rooms are being viewed as necessities by many prospective students.

Related information
A Short History of the Cost Commission
A third component noted by the cost commission which has changed the production function for higher education is the extensive set of applicable government regulations.

The changing population of students who are taking advantage of higher education, including those with disabilities of various types, has significantly increased the cost of producing higher education. The physical changes which many institutions have been required to make in order to be accessible to the mobility impaired cost relatively little when compared with the ongoing costs most institutions are incurring to provide services to the hearing impaired, visually impaired and learning disabled—sometimes more than $40,000 a year for a single student.

The commission discusses three “costs” which really are prices: sticker price, total price and net price.

Colleges and universities are most frequently taken to task for the run-up in the sticker price—the published price for tuition and fees—which has occurred over the last several years. The commission presents data showing that, depending on the type of college, the sticker price has increased between 84 percent and 141 percent between 1987 and 1996, and that the net price—considering all financial aid and sticker price—have increased similarly.

However, the National Association of College and University Business Officers (NACUBO) institutional financial aid study for independent colleges and universities indicates that the sticker price of the more than 300 institutions in its study has increased 54 percent between 1990 and 1997, while the net price—considering only institutional grants—has increased by only 33 percent.

Which price is relevant? At the independent colleges and universities in the NACUBO study, the rate of discounting for freshmen has increased from 26 percent of the sticker price in 1990 to 37 percent in 1997. In addition, the percent of freshmen who are receiving institutional grants at the independent institutions in the study has increased from 61 percent to 76 percent. At more than a third of the institutions, less than ten percent of the freshmen actually pay the sticker price.

Colleges are motivated to follow this strategy of discounting, even though they are encountering great adverse publicity about price increases, for a variety of reasons. First, by selectively discounting from the published price, colleges are able to shape their class in terms of the types of students they most want. At all but a handful of the most selective colleges in the country today, financial need is no longer a necessary prerequisite for receiving aid at a private institution.

For many years we have been comfortable with the notion that Division I institutions offered athletic scholarships based on ability; now this strategy of discounting to students with other desirable criteria has been almost universally adopted.

At institutions where almost all students receive institutional grant aid, why is this strategy followed rather than across-the-board price reductions? One answer seems to be the “Chivas Regal effect”: belief in a positive correlation between price and quality. A second reason is that there is a widespread fear that a reduction in the sticker price will be viewed as an act of desperation in order to fill a class. Furthermore, the few institutions that have made substantial reductions in the sticker price have not had overwhelming success with this strategy, and, perhaps more importantly, their competitors who continued to increase their prices were not hurt by this competition.

  Related information
  Chart comparing Congressional Requests with the work of the National Commission on the Cost of Higher Education
Another reason for the strategy of discounting to most students is that we are a society which wants to get things on sale; we want to get a deal. We are a coupon society. How often do we buy something that is marked down 30 percent and feel we have been terrific shoppers without assessing whether the original price was reasonable? This type of thinking is having an influence on college pricing.

Is this pricing strategy one that will work for the long haul? The jury is still out on this question. At the moment it seems to be working quite effectively for a large number of institutions. Each year, more institutions are moving away from need as their only criterion for aid. The sticker price continues to increase at rates far in excess of inflation while the increase in the net price is much closer to the rate of inflation.

Is this pricing strategy appropriate for higher education? This is a strategy which relies on imperfect market information to succeed. It results in most classrooms being filled with students who are paying different prices which often are based on willingness to pay rather than on ability to pay. In the past, subsidies to students with a financial need have been acceptable to us as a mechanism for equalizing opportunity; this new strategy must be justified as being necessary to provide the mix of students essential to an appropriate educational experience.

Finally, the commission’s discussion of total price has left out perhaps the most significant component: opportunity cost or foregone wages.

The most significant cost of going to college for most students is the wages that they would have made had they been in the labor force full-time. Had they entered the labor force with their high school diploma, they would have earned between $14,000 and $20,000 a year. And since those who go on to college are probably among the more intelligent students, their foregone earnings are likely to be even higher. This is a cost which the students bear directly, and it should be recognized in any discussion of the price of college attendance.

The last issue I want to address relates to the benefits of higher education. The commission has not dealt with this topic. What are the returns from higher education, to the society and to the individual, and how should these impact our perspective on higher education?

Harking back to the human capital writings of Gary Becker and the economic analysis of Denison, the data indicate that a democratic society requires an educated populace. This is substantiated by the direct positive correlation between participation in governmental affairs—explicitly the increase in voting rates—of college-educated people compared to individuals with less education.
There also are other non-pecuniary benefits which are ascribed to higher education. These include lower crime rates and more cultural activities.

We must not lose sight of the significant contributions which higher education makes to a prosperous economy and a democratic society. In all of our discussions and concerns about the cost/price of higher education, we often lose sight of the greater good. As this country continues to increase its reliance on a highly educated work force, we see the returns to higher education continuing to increase. This requires us to insure a strong system of higher education.

There also are significant direct pecuniary gains to higher education for the individual. The rate of return to a college degree has been increasing in recent years. A person with a college degree is predicted to make about 150 percent more over a lifetime than an individual with only a high school degree.

Given the large pecuniary return, one question must be asked: Does the government need to subsidize higher education?

The answer is that a subsidy is required. There is a very imperfect capital market which makes financing a college education difficult. And there is concern about the adequacy of production of college educated people without a subsidy, since all of the returns do not accrue to the individual.
Current capital markets do not appropriately take into account the projected rate of return to a college degree, and banks are unwilling to lend over the length of a working life. u

Photo by John Harrington / Blackstar

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