College Rating Systems and Higher Education Market Failures

Introduction: The College Rating Plan

The Obama administration is attempting to create a rating system that will rate colleges based on their quality, affordability, and outcomes (Leonhardt, 2014). The goals of the program are to allow prospective students to compare colleges and to create an incentive for colleges to provide students with a good and affordable education (Leonhardt, 2014). The college-rating plan will measure the average net price of the college, completion rates, and graduates' earnings (Leonhardt, 2014).

In a time of increasing tuition prices, where college degrees remain necessary for economic prosperity, a rating system could create better information transparency and encourage stronger competition between colleges. By providing standardized metrics for quality, cost, and outcomes, such a system could help students make more informed decisions about their educational investments.

Higher Education as Public and Private Good

The current problems associated with higher education are consequences of both government failures and market failures. Higher education can be considered both a private and public good (Rampell, 2014). It functions as a public good because it is non-rivalrous in consumption (Marlow, 1997)—that is, one person's education does not diminish another's ability to benefit from education.

However, higher education also exhibits private good characteristics because it has the ability to exclude people, such as by charging tuition (Marlow, 1997). If higher education is more of a public good, then market failure occurs because it under-allocates the amount of higher education demanded (Marlow, 1997). Furthermore, since marginal costs are zero, achieving allocative efficiency would require all beneficiaries to be allowed access to higher education (Marlow, 1997).

The public generally views higher education as a public good, but today it is increasingly being treated as a private good (Rampell, 2014). Politicians are shifting the burden of expenses away from taxpayers and onto the shoulders of students. If education is treated more as a private good, then the market failure stems from information asymmetry and a failure to allocate resources on the basis of full social cost (Marlow, 1997).

Market Failures and Government Intervention

The government attempts to correct market failure by subsidizing higher education. However, these subsidies have been identified as contributing to rising tuition costs by fueling the tuition price boom (Lane, 2013). Financial aid allows families paying for college to be more price inelastic—less sensitive to price changes—which in turn allows colleges to raise tuition with less resistance (Lane, 2013).

Colleges and academic programs that do not have positive returns on education would fail in a free market, but subsidies have allowed them to continue operating (Lane, 2013). These failures have occurred because of government intervention, and now students are paying high tuition prices without clear knowledge of their return on their college education investment (Wall Street Journal, 2015).

Society receives many benefits from college-educated citizens, including a more innovative and productive labor force as well as more active citizenship (Bauml & McPherson, 2011). There are social benefits to having more college graduates; therefore, the government is able to rationalize college subsidies because the market fails to account for these social benefits (Rampell, 2014).

Information Asymmetry and Consumer Decision-Making

The government is attempting to correct information asymmetry by creating the college-rating plan (Marlow, 1997). For the free market to function optimally, college students must assess the college they are about to attend and decide what price they would truly be willing to pay for that education (Marlow, 1997).

However, if students are unaware of the quality, affordability, and outcomes of their education, they might have made a different decision had they possessed complete information (Marlow, 1997). The rating system seeks to address this knowledge gap by providing transparent, comparable data that enables students to evaluate the actual value proposition of each institution.

Conclusion: Market Failure vs. Government Failure

The federal government's reason behind creating a College Rating Plan is a response to either the market's failure or the government's failure. If it were the government's failure, then this plan would only be a small fix to a bigger problem. If it is more of a market failure, then the rating plan could help students obtain more information and create incentives for more affordable and quality colleges.