The Role of Colleges within the Higher Education Sector

Over the past decades the college sectors in the higher education systems of many Western countries have expanded their capacities massively. This happened even though colleges have been at a competitive disadvantage with universities which are publicly subsidized, while colleges must self-finance through tuition fees. The question arises how, in equilibrium, a diverse student population is allocated between these institutions and whether the resulting human capital accumulation process is efficient. Our paper explores these questions within an information-based theoretical framework. Individuals are screened for their (unobservable) innate abilities, and the precision of the screening mechanism, which is endogenous, balances demand and supply of educational services. We find that in the short term, when the college capacity is fixed, college subsidies are not desirable in most cases. In the long term, the college sector may expand excessively thereby establishing inefficiently low screening standards in the admission process to higher education.