Who pays for higher education?  This is a loaded question and on the minds of many these days.  President Obama, many governors, parents, and students all want to understand why tuition keeps climbing.  As is the case with many vexing problems, the answer to this question is a complicated one.

In today’s post, I will explain the basics of costs, price, and subsidy in higher education.  On Monday, I will detail the current state of higher education costs and price.

There are three important concepts to understand in order to discuss higher education financing.

Cost:  How much a university spends per student

Price:  How much a university charges in tuition and fees

Subsidy:  The difference between cost and price typically paid by state appropriations, endowments, or institutional funds.

One of the major problems in discussing the increase in tuition is that the concepts of cost and price get confused with one another.

In both public and private universities, revenue from tuition and fees only cover a part of the cost to educate a student.  The rest of the costs are paid for through subsidies from government and private sources.

Take an analogy that everyone is familiar with:  buying a car.  Let’s say it costs Honda $14,000 to make an Accord.  The dealer sticker price for the Accord that cost $14,000 to produce may be $28,000.  But we also know, no one pays sticker price.  I’m a good negotiator and get the dealer to sell me the Accord for $20,000.

$20,000 (price) – $14,000 (cost) = $6,000 (profit)

In this example, I pay $20,000 for a car that cost $14,000 to produce.  The dealer and manufacturer made $6,000 in profit.  This is how it works for a for-profit company.  The price paid has to cover not only the cost of making the car, but also profit for the dealer and manufacturer.

Now, we can compare this to higher education.  Let’s say it costs a public university $14,000 to educate a student.  The tuition sticker price for our example university is $16,000.  But like a car, no one actually pays sticker price for a college either.  Instead, the student pays $10,000.

$14,000 (cost) – $10,000 (price) = $4,000 difference/subsidy

This is where the example differs.

The price I paid for the car still exceeds the cost of producing the car as well as profit for the dealer.  In the higher education example, the price a student pays is $4,000 less than it costs to educate the student.

Someone must pay for these costs.  This is where the subsidy concept comes into play.  For the sake of argument, let’s say government funding pays $3,000 and private gifts and endowments pay $1,000.  As a result, the student pays $10,000 and these other sources pay $4,000.

$14,000 (cost) = $10,000 (price) – $3,000 (government funding) – $1,000 (private gifts and endowments)

But what happens if the government cuts the amount it pays for a student’s education (if only this was a hypothetical!).  Due to cutbacks, the government will not continue paying $3,000 per student but is now going to pay $1,000.

$14,000 (cost) = $12,000 (price) – $1,000 (government funding) – $1,000 (private gifts and endowments)

It still costs the university $14,000 to educate the student.  If we subtract the $1,000 the government now pays and the $1,000 in private gifts and endowments, we are left with $12,000.  The result is that the price the student pays has now increased from $10,000 to $12,000 even though the cost to educate the student is unchanged.

The real winner in all this is the politicians.  They get to brag about cutting taxes and spending while chastising the university for increasing tuition so much.  Yet, it is their policies driving up tuition in the first place.  In Monday’s post, I will put some actual totals to these examples to explain the changes in higher education cost and price in recent years.