The Park Place Economist

Volume 4 Issue 1 Article 16

5-1996

The Market Structure of Higher Learning

Brett Roush '97

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Recommended Citation Roush '97, Brett (1996) "The Market Structure of Higher Learning," The Park Place Economist: Vol. 4 Available at: https://digitalcommons.iwu.edu/parkplace/vol4/iss1/16

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Abstract A student embarking on a college search is astounded at the number of higher learning institutions available -- an initial response may be to consider their market structure as one of perfect competition. Upon fkrther consideration, though, one sees this is inaccurate. In fact, the market structure of higher learning incorporates elements of monopolistic competition, oligopoly, and monopoly. An institution may not explicitly be a profit maximizer. However, treating it as such allows predictions of actions to be made by applying the above three market structures. Such predictions include the quantity of education offered as well as advertising tendencies (Section 11), scrutiny of competitors (Section III), and price discrimination (Section IV).

This article is available in The Park Place Economist: https://digitalcommons.iwu.edu/parkplace/vol4/iss1/16 The Market Structure of Higher Learning

Brett Roush

I. INTRODUCTION demand curve is downward-sloping. To maximize profit, an institution's offered A student embarking on a college search is enrollment will be the level at which MC = astounded at the number of higher learning MR (see FIGURE 1). Though the quantity institutions available -- an initial response may can be predicted, in this analysis the price is be to consider their market structure as one of not yet determined. Simple mark-up pricing, perfect competition. Upon fkrther characteristic of a monopolistic competitor, consideration, though, one sees this is does not apply, as this paper will later inaccurate. In fact, the market structure of demonstrate. higher learning incorporates elements of monopolistic competition, oligopoly, and FIGURE 1: Quantity Supplied , monopoly. An institution may not explicitly be Monopolistic Competition a profit maximizer. However, treating it as such allows predictions of actions to be made by applying the above three market structures. Such predictions include the quantity of education offered as well as advertising tendencies (Section 11), scrutiny of competitors (Section III), and price discrimination (Section IV). IL MONOPOLISTIC COMPETITION

Though thousands of firms offer their product - an education and degree -- each has Q, unique aspects. Campus envircknent, faculty, Quantity academic reputation, location, and countless other differentiate one institution Another important ramification of this fiom another. However, each institution's model - that advertising expenditures are product is a substitute for the others'. (Some significant - relates to the higher education are closer substitutes, of course -- Yale and industry. Each institution has extensive Southwestern Kentucky Bible School are not advertising, both informational (through such equally good substitutes for Harvard). Since mediums as Peterson's Guides and direct each institution has a monopoly over its own mailings to potential applicants) and product and product differentiation is evident, glamorous (such as sports recognition and $25 higher learning can be modelled as a million science buildings). The institution's monopolistic competition market. name is plastered on merchandise, alumni are The first prediction made by the encouraged to express pride in their alma monopolistic competition model is the mater, and the "publish or perish" doctrine at equilibrium quantity supplied. With product many research institutions means you must differentiation, the individual institution's elicit recognition for your name -- and the The Park Place Economist, v. 4

institution's name. Combined, these methods These divisions are made for athletic make advertising a central concern of each competition, but what underlies them? Each institution, as the monopolistic competition division encompasses institutions with similar model predicts. qualities, such as size, student characteristics, Theoretically, the amount of advertising and location. More importantly, a consumer would be such that the marginal revenue from typically chooses one or two of these one extra advertising dollar equals that dollar; categories and then decides among the schools alternatively, the marginal revenue of the included. In a sense, a small number of fhs advertisimg dollar equals the price elasticity of sell to a specific group of consumers in a niche demand. Whether an institution implements of the higher education market. Since the this efficient level is not easily discernible. market is plausibly divided into small units First, many forms of advertising, such as and, as explained earlier, there are barriers to constructing a flashy new building, have entry, an oligopolistic model is appropriate. benefits other than simply increased revenue. One of the few definite predictions the Others, like merchandise bearing the oligopoly model makes does pertain to higher institution's insignia, may actually have no cost learning. This market structure's theory since the advertising itself represents revenue. contends that each institution will scrutinize Moreover, such elements as marginal revenue the others' actions, and must consider fiom advertising expenditures and price reactions when planning their own actions. . elasticities are difficult to estimate. The This most certainly occurs. WU observes determination of an institution's efficiency in policies in other small liberal arts universities -- advertising expenditures would be an extensive for example, Dr. Robert Leekley compared research project. faculty salaries and benefits of area An important prediction of the institutions. Also, I recall an article in my monopolistic competition model that does not freshman seminar detailing the monitoring by describe higher learning is that long-run top East coast universities of Duke's economic profits are zero. This conclusion is revolutionary multi-cultural programs. based on the ease of entry and exit of firms, Also, collusion is possible. An example of but higher education presents significant formal collusion would be the small college barriers, such as the necessity for a reputation consortium, where many small colleges in and the large amount of capital required to Illinois unite for employers to recruit students. open an institution This paper will show that, Total benefits are increased - working in fact, long-run profits are possible. individually, each institution would not attract many recruiters. Informal collusion may exist m. OLIGOPOLY as well. I recall rumors of Ivy League admissions counsellors meeting in order to The previous model has another substantial diwy up financial aid for students (who shortcoming when applied to the industry of generally apply to multiple institutions in that higher education - the substitutes vary widely, oligopoly). as mentioned earlier. Instead of one The previous conclusions (under a comprehensive market with some good and monopolistic competition assumption) some poor substitutes, the market is concerning advertising and product segmented into small groups of institutions differentiation are not invalid with an that are considered nearly perfect substitutes. oligopolistic interpretation. Mansfield (1994) Some of this segmentation is reflected in the declares that "In many oligopolistic industries, sports listings: Big 10, PAC 8, Ivy League. firms tend to use nonprice competition, like Roush

advertising and variation in product FIGURE 2: Price Discrimination characteristics." This makes sense, since In a Mompoly institutions initially attract students with their reputations and programs rather than p, competitive prices. IV. R MONOPOLY Once an institution is chosen, the market $ structure changes drastically. As mentioned g - before, an institution has a monopoly on its W own product. Also, once a student enters an institution, barriers to entry occur, diierently than described earlier. In this case, it is the consumer, the student, who finds barriers in Q, attempting to bring his business to another Quantity firm. The rigmarole of physically transferring, refinancing, and acclimatizing the student and above and some below the typical price, PE his past course work to a new institution all (see FIGURE 2). If this price were universally help prevent changing the institution providing charged, many students would be unable to the education. Thus a monopoly market attend and the revenue that they offer would - structure applies. be forgone. Here a monopoly's ability to price k The most fascinating application of this diitebecomes pertinent. k structure lies in pricing. In a typical The hitution, ndgat least the shaded monopoly, the profit-maximizing price would area to break even, utilizes financial aid forms be at the price illustrated by the demand curve in an attempt to ascertain each student's at the quantity offered. In this case, though, maximum abity to pay. Ideally, each two interesting variations exist. First, the enrollment fee will be the one shown on the quantity was determined in the monopolistic diagram. competition market structure, so &intity Government assistance complicates this supplied is less than it would be under a typical situation; I am unsure exactly who gives and monopoly. Second, a conflict develops receives the payments, so I am unable to concerning the profit-maximization strategy. analyze them. Essentially, though, perfect The greatest short-run profits would be information and first degree price achieved by using price as a rationing discrimination are the institution's goals, as instrument - admi$ii only those who could these would allow all of the potential pay the most. However, long term profits are consumer surplus to become revenue. harmed if the reputation suffers due to An important point is that the institution unqualified (but wealthy) students being Jaws money on student 3, who can only afford admitted. In other words, maximizing long P3. As mentioned in the introduction, profit term profits requires a difFerent strategy than maximization is not the only goal of an maximizing short term profits. Assuming institution; need-blind admissions permit a need-blind admissions, the following analysis deserving but costly student to receive his

' ought to be accurate. education. Suppose 3 students are admitted, each at Another pricing technique of a monopoly, distinct spots on the demand curve -- some bundling, occurs as well, since students must The Park Place Economist, v. 4

often purchase housing, meal plans, and books point. Second, as mentioned before, an from the institution. The monopoly power and institution's advertising often accomplishes stringency of pricing techniques of an other goals; only a portion of a dollar spent is institution should increase over time, as the "lost" to advertising. transferring process highlighted earlier Scrutiny of other institutions and collusion becomes more impractical. However, I have are accurately predicted if the oligopoly model not noticed significant payment changes as a is accepted. Finally, once a student enrolls, a second-year student, and I believe bundling monopoly structure applies, and price actually decreases, as living off campus is discrimination and profit-maximizing permitted in later semesters. techniques are employed. As a monopoly, long-run profits are possible, especially with V. CONCLUSION the aid of the aforementioned pricing policies. By employing various market structures When an institution is being chosen by a describing higher education, a fair amount of potential student, either the monopolistic institutions' actions are predictable. competition or oligopoly model applies. Perhaps the latter is more applicable; as is so REFERENCES often the case, economic theory is difficult to apply to real-world phenomena. However, Leekley, Robert. "IWU Faculty regardless of which market structure applies, Compensation." Lecture presented at significant product differentiation and large Illinois Wesleyan University, 18 September advertising costs result. In this case, the oft- 1995. made conclusion that inefficiently excessive advertising exists does not apply. First, much Mansfield, Edwin. Microeconomics, 8th ed. of the advertising is informational and assists New York: W.W. Norton and Co., 1994. students in making probably the most important decision of their lives up to that

Brett Roush ('97) wrote the above paper for his Intermediate Microeconomics class. He is combining a major in Economics with minors in Risk Management and Mathematics, and hopes to become an actuary.