Why School Tuition Is So Expensive: A Lesson In Opportunity Cost


It’s the beginning of the year again, and students are filling the halls of universities and colleges across the United States.  Touted as essential to the “American Experience,” students are leaving their homes at the advisement of parents to pursue their educations.  It can be said that in today’s world, there is almost nothing more desired–or even needed–than an education that would adequately qualify us as participants in the “American Dream”.

This year though, things are different. 
We are in a prolonged recession.  Real unemployment is very high.  Deficit spending is at a record high.  Our national debt now exceeds our Gross Domestic Product.  Let’s not even talk about the interest our country owes against our national debt.  We have wars and rumors of wars.  Political discussion has become polarized and has been overtaken with evil intent.  It’s becoming difficult to be hopeful, as it is becoming more and more clear that the change that we desperately need may never actually come.

Because of these reasons and more, colleges and universities have been seeing a very significant upward trend in enrollment over the last few years.  The National Council for Educational Statistics1 reports that there are more students applying for admission into higher educational institutions this year than in any prior year (an estimated 20.7 million2).  In 1990-1999 and 2000-2009, overall enrollment increased 38 percent and 45 percent, respectively.  Non-traditional students make up 63.15% of all new enrollments during the 2000-2009 time period1.  Total enrollment is projected to continue setting records each year, ultimately reaching about 24 million students by the Fall of 20192
Just like our demand for quality education, tuition prices have never been higher.  According to Bloomberg and the College Board3, the average tuition increases last year was 8.3% at public universities (almost three times the rate of inflation), and 4.5% at private universities.  At an average tuition increase of 8.3% per year, the price of college will double in 9 years.  It’s also important to notice that the ten-year historical rate is 6%4, which doubles college prices after a period of 12 years.  From looking at the data, it is clear that our college prices are rising at much faster rates than our nation’s inflation and average wage. 
At the end of the day though, what really matters are completion rates.  In a report by the Organisation for Economic Co-operation and Development (OECD)5 which is based on data up until 2007 derived from 30 member countries, it was reported that the United States completion rate ranked first in 1995.  In 2007 however, we had fallen to 14th with a 36.5% completion rate, well below the OECD average rate of 39%.
“What that tells you is that a number of other countries have been much more successful in expanding their higher-education systems,” [says Andreas Schleicher, head of the OECD unit that produced the study.] “The United States has fallen so far behind in higher-education completion, and private costs have become so high, that some people are suggesting that tuition has become a barrier to extending participation.”

So, we have evidence of a tuition barrier.  It’s actually becoming so expensive that people must drop out of school because they cannot afford it.
What is the primary cause of this trend of expensive schooling?  The short answer: subsidy.  More specifically, federally guaranteed financial aid (student loans and grants included).  Why does financial aid drive up the prices of school you ask?  The answer lies in a basic understanding of how opportunity cost works.
In economics, opportunity cost is defined as “the cost of an alternative that must be forgone to pursue a certain action.”  Put another way, opportunity cost is a measure of the benefits you could receive when you take an alternative action instead.
To better understand opportunity cost try to visualize a really nice, brand new big screen TV that you would love to have in your living room (or room).  However, when you see the price tag, your mouth drops.  If you were to buy this TV you would have to give up eating at Red Lobster weekly for 5 or 6 months to afford it.  To you, that’s too expensive–because you really like your weekly outings to Red Lobster, more than you would love having that really nice big screen TV in your room.  That’s your opportunity cost, and in this case, your opportunity cost is too high.  The lower your opportunity cost for a good, the more affordable that good is to you.  Get it?
University tuition can be explained through this same economic principle.  Put simply, Federal Financial Aid disbursements can be considered extra capital for spending that would not normally be there if the Federal Government did not provide aid at all.   

If you help someone pay for something, they can pay more for it—and for more of it.
The purpose of Financial Aid is to lower a student’s opportunity cost for a college education so they will be more likely to purchase.  In other words, Financial Aid is there to make college “more affordable” in the short term (even in spite of inflating prices).  Of course, we all know that Financial Aid is not accessible to everyone.
Like any business or industry, a college’s main incentive is to increase revenue.  The way they do this is by charging students the most they possibly can for their service and bringing in as many new students as possible.  
So the explanation goes like this:  the more students that have Financial Aid for college tuition, the more Colleges can “get away with” charging more money for tuition every year–because there are more people that can afford the higher prices.