Working Paper: CEPR ID: DP5011
Authors: Robert J. Garybobo; Alain Trannoy
Abstract: A student's future log-wage is given by the sum of a skill premium and a random personal ?ability? term. Students observe only a private, noisy signal of their ability, and universities can condition admission decisions on the results of noisy tests. We assume first that universities are maximizing social surplus, and contrast the results with those obtained when they maximize rents. If capital markets are perfect, and if test results are public knowledge, then, there is no sorting on the basis of test scores. Students optimally self-select as a result of pricing only. In the absence of externalities generated by an individual's higher education, the optimal tuition is then greater than the university's marginal cost. If capital markets are perfect but asymmetries of information are bilateral, i.e., if universities observe a private signal of each student's ability, or if there are borrowing constraints, then, the optimal policy involves a mix of pricing and pre-entry selection based on the university's private information. Optimal tuition can then be set below marginal cost, and can even become negative, if the precision of the university's private assessment of students' abilities is high enough.
Keywords: examinations; higher education; incomplete information; state subsidies; tuition fees
JEL Codes: D82; H42; I22; J24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Capital markets are perfect and test results are public knowledge (G10) | Optimal policy entails a positive tuition fee without sorting based on test scores (H49) |
| Optimal policy entails a positive tuition fee without sorting based on test scores (H49) | Students self-select based on pricing (D49) |
| Universities have private signals of student ability (D29) | Optimal policy mixes pricing and pre-entry selection (D49) |
| Optimal policy mixes pricing and pre-entry selection (D49) | Tuition potentially set below marginal costs (D29) |
| Rent-seeking universities operate inefficiently (D29) | Tuition fees are set too high and admission standards too low (I23) |
| Students face borrowing constraints (G51) | Optimal policy must combine pricing and selection (D40) |
| Optimal policy must combine pricing and selection (D40) | Tuition below marginal costs to alleviate inefficiencies (D61) |