Why are high-achieving, low-income students less likely to apply to selective colleges despite the generous financial aid typically offered? To reconcile this seeming puzzle, an equilibrium model of the U.S. college market featuring tuition discrimination and a noisy application and admissions system is presented and estimated. Students, who differ in their financial resources and innate ability, can apply to multiple colleges and are uncertain about their prospective admissions and financial aid. Colleges in turn only observe a signal of students’ ability and compete by choosing admission standards and tuition schedules. Low-income students receive generous financial aid at selective colleges because only the highest-ability among them apply, making their signals highly informative. If signals became less informative (e.g. colleges stopped using the SAT), high-ability students would be worse off and only high-income, low-ability students would benefit. Finally, there are welfare gains from increasing need-based financial aid (e.g. Pell Grants). Despite its fiscal cost, the policy would greatly benefit low-income, high-ability students.
Presentations: UPenn, Washington University EGSC Conference, Warwick Economics PhD Conference