Sorting of Students into Colleges: Inefficiencies and Policy Implications

How efficient is the sorting of college students into colleges of varying quality? We develop a general equilibrium lifecycle model of human capital accumulation that allows us to tackle this question. Our framework explicitly features the variation in college quality, which we measure in the data as the average test score of the freshmen class. Higher quality colleges provide access to a superior human capital accumulation technology, but charge higher tuition and impose stricter standards on their students. We discipline this model by matching college quality choices, college credit accumulation histories, dropout and college transfer behavior, as well as earnings histories for different types of students in NLSY 1997 cohort. These data, when viewed through the lens of the student decision making, help us identify the human capital accumulation technologies and provides insight into student sorting among colleges of varying quality. We employ the calibrated model to quantify the importance of financial constraints in generating sorting inefficiencies and compare their impact on the evolution of student sorting among colleges between the 1979 and 1997 NLSY cohorts. We then ask which policy is most effective at improving upon outcomes, focusing on merit-based and need-based financial aid.