Price Elasticity

Soon enough, boards and presidents, committees and task forces, will take up the question of setting tuition for next year. The discussion must vary considerably from institution to institution, but for tuition-driven privates, it's a nail-biting exercise.

The unthinking version goes like this:

President: Well, we have all the budget requests now. How short are we?
Finance VP: We're a million short, after trimming.
President: How much do we have to raise tuition in order to close the gap?
Finance VP: (calculating) About seven percent.
President: Great. That settles that. Next on the agenda is the parking problem.

The list of reasons why this won't work is long. First, one must of course account for additional financial aid awarded when the tuition goes up: probably in the neighborhood of 40% of the gain. But it could be worse than that. It might happen that net revenue actually decreases when one raises tuition. This is related to price elasticity or price sensitivity: how does the demand for education at your fine institution vary with cost?

I have started a survey of ideas out there for approaching this problem, and this post will provide links to some articles. Down the road, I'll try to give more analysis and detail. For several of the articles, you need access through your library to get them.

University Business takes the question head-on with "Research Tools to Guide Tuition and Financial Aid Decisions," from 2007 but still quite applicable. They describe a tuition pricing study:

A tuition pricing study involves a blind survey of prospective students and their parents. Since response rates are better, and the sample can be controlled more carefully, most studies are conducted via telephone.

Here's an old (1995) article called "Tuition Elasticity of the Demand for Higher Education among Current Students" in Journal of Higher Education. An even older (1987) article in the same journal is "Student Price Response in Higher Education."

A 1997 case study can be found in "Some new evidence of the character of competition among higher education institutions" in Economics of Education Review.

There are a lot of old papers you can find on google scholar, but not many recent ones. Here's a magazine article, again from University Business (2003) "Overcoming price sensitivity ... Means marketing affordability, and it's what every IHE needs to do.(On The Money)" that makes an interesting charge:

Unfortunately, the financial aid award letter itself, although a critical component of communicating affordability, comes too late in the process to influence anything but yield on admitted students--significant, certainty, but in many instances, not sufficient.

This is an interesting practical problem, and the article poses some great solutions. Forward this one to your FA director today. Seriously.

If you like economics, you may find this one palatable: "Admission, Tuition, and Financial Aid Policies in the Market for Higher Education," in Econometria (2006). Their models shows "that the model gives rise to a strict hierarchy of colleges that differ by the educational quality provided to the students." Also:

Our empirical findings suggest that our model explains observed admission and tuition policies reasonably well. The findings also suggest that the market for higher education is quite competitive.

It's very dense with formulas. I'll try to read the tea leaves when I have more time.