By Jonathan B. Wight

Government financing of higher education (through student loans and grants) leads to an increase in demand for higher education.  As demand shifts right, we move up the supply curve of higher ed.  What does that do to the price of education?

If the elasticity of supply is high, that means that it is relatively easy to add to capacity, and output expands with little rise in price, assuming a competitive marketplace.

But there are two things wrong with this: first, labor inputs in the higher ed world are limited, which is another way of saying the quality varies greatly. The research quality of people hired by Stanford is markedly different from the research quality of people hired by a local community college. 

Second, if research quality determines reputation in the academic world, and if reputation affects demand, then we no longer live in a world of perfect competition because the products being sold are not homogenous—identical.

Rather, we now live in a world of limited supply of high quality educational offerings. This supply curve is relatively inelastic, because it takes a long time and a lot of money to create reputation. And since the existing high quality schools may disproportionately set the standards for accreditation, they can lead others down the path of emphasizing research over simply teaching.

The result is that as demand increases, tuition prices surge (see chart). 
This is not rocket science, and was recently supported by research from the New York Fed, as reported by Jim Bacon on Bacon’s Rebellion. The conclusion Bacon draws is that:

“Little of the money has gone to hire more professors, increase faculty pay or otherwise improve the quality of education. Most of it has paid for bloated administrations. Meanwhile, outstanding student-loan debt has skyrocketed to more than a trillion dollars, creating a new class of indentured servants.”

“This is the hardest evidence yet that one of America’s most ideologically liberal institutional complexes, higher education, is also one of the most exploitative. Colleges and universities talk a good game about social justice, but in the end, they put their institutional prerogatives first.  In the end, higher education has become a powerful engine of social injustice.”

I can corroborate this from my years in Brazil, where higher education was not only subsidized, it was free.  All you had to do was get in. But only rich kids had access to excellent high schools.  As a consequence, society provided a free ride for rich kids to add to their human capital in college, paid for by the taxes on the poor.  And virtually all of these kids were white, adding to Brazil's racial injustice.

Two chapters in my book, Ethics in Economics, deal with economic injustice and economic opportunity.

[Chart source: http://www.federalreserve.gov/pubs/feds/2011/201103/index.html]