Empirical studies have found that high achieving, low-income students are less likely to apply to selective colleges despite the generous financial aid typically offered. To reconcile this seeming puzzle, we build a structural model of the U.S. college market featuring tuition discrimination and a decentralized admissions system. Students, who differ in their financial resources and innate ability, apply to a subset of colleges and are uncertain about their prospective admissions and financial aid. Colleges observe a noisy signal of student ability and compete by choosing admissions standards and tuition schedules. We find in our estimated model that differences in application rates are due to student expectations over admissions and financial aid, which are consistent with college policies in equilibrium. 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), all high-ability students would be worse off and only high-income, low-ability students would modestly benefit. Finally, we find overall welfare gains from increasing Federal need-based financial aid, which would greatly benefit low-income, high-ability students by alleviating credit constraints.
Presentations: Washington University EGSC Conference, Warwick Economics PhD Conference, UPenn