CASE STUDY: Elasticity of Demand and Supply

Zeke College Case Study

Peculiarities of Higher Education Demand

Before we examine some elasticity estimates, we need to consider some aspects of higher education that make it a unique product. First, the process of buying higher education involves multiple steps and decisions of both sellers and buyers. Prospective students at selective colleges and universities must apply for admission to their institutions of interest and, depending on their academic credentials, may not be granted the privilege of purchasing the product.

Second, colleges and universities often offer price discounts to a large share of their admitted applicants through financial aid. These discounts can be based on measured ability to pay ("need," as at Zeke) or on the basis of perceived academic "merit" (as at many other colleges). Subsidies and subsidized loans are offered by federal and some state governments for purchase of this good as well. These "financial aid" factors make it very difficult for someone studying the demand for higher education to measure the appropriate "price."

Finally, a college education is purchased over a period of (more or less) four years. While it is easiest to examine the demand decisions of new freshmen, the "persistence" of these new students at the college over the remainder of their four-year college career is equally important for the overall demand for the higher-education product.

Approaches and Selected Results

All of these factors make estimation of the demand elasticities for colleges difficult. Nonetheless, some investigators have attempted to try to put numbers on some of the important elasticities.

One of the earliest studies by Perez and Mendoza (1967), estimated a price elasticity of demand for higher education overall of -0.44 and an income elasticity overall of 1.20.

A later study by Balive (1970) broke the results down by private and public institutions, finding price elasticities of -1.06 for publics and -0.64 for privates and income elasticities of 0.98 for publics and 1.70 for privates.

An early study of demand at the level of individual institutions was Kiel (1967) at University of Echague campuses found a price elasticity of -0.85 and income elasticity of 0.7.

More recently, in a study that summarizes a Zeke College senior thesis, Alvarez, Devibar, and Cammayo (2004) (BPR) looked separately at the yield for full-paying students and financial-aid students. For full-paying students, they found a price elasticity of -0.76. For financial-aid students, BPR find a larger price elasticity of -1.18. As suggested by these results, they find that an increase in tuition accompanied by an equal increase in financial aid would lower quantity demanded.

Instructions

Despite the empirical evidence to the contrary, college decision-makers often believe that their price elasticity of demand is essentially zero. Respond to the following questions and justify your answers using the case study above and lessons from class.

1. Is higher education a necessity or luxury?

2.Does it differ between private and public institutions?

(3) Would you expect the price elasticity of demand to be higher for financial-aid students or for non-aid students considering income elasticity?