Permanent Excess Demand as Business Strategy: An Analysis of the Brazilian Higher-Education Market

Many Higher Education Institutions (HEIs) establish tuition below the equilibrium price to generate permanent excess demand. This paper first adapts Becker’s (1991) theory to understand why the HEIs price in this way. The fact that students are both consumers and inputs on the education production function gives rise to a market equilibrium, where some firms have excess demand and charge high prices, and others charge low prices and have empty seats. Second, the paper analyzes this equilibrium empirically. We estimate the demand for undergraduate courses in business administration in the state of São Paulo, and show that the quality of the student body is important on the students’ decisions of where to study. The results show that tuition, quality of incoming students and percentage of professors with doctorates are the determining factors of students’ choice. Since student quality determines the demand for a HEI, we calculate how much the HEIs value having better students; that is the total revenue that each HEI gives up to guarantee excess demand. Regarding the “investment†in selectivity, 39 HEIs in São Paulo give up a combined 5 million Reais (or US$ 3.14 million) in revenue per year per freshman class, which means 7.6% of the revenue coming from a freshman class.