University choice, peer group and distance

We analyze how authorizing a new university affects welfare when the students' education depends on the peer group effect. Students are horizontally differentiated according to their ability and the distance from the university. Comparing a monopolistic university with a two-universities model we find that allowing a "new" university is welfare improving when the monopolistic university is only attended by able students with less mobility constraints. This occurs when mobility costs are sufficiently high. When mobility costs are low, a negative externality arises and welfare decreases. The negative externality comes through the peer group effect - high ability students that would have gone to the monopolistic university go to the university with the lower average ability. These students end up in a university with students whose ability was not high enough to go to the monopolist. On the other hand, students remaining in the good university benefit from a lower average ability. Thus, a new university is welfare improving only for those with low ability that in the monopolistic scenario would remain unskilled. When, instead, the mobility cost is high, the monopolist leaves out a significative mass of individuals. In this case, no negative externality arises because no student swaps university therefore a "new" university is welfare improving. However, this welfare improvement makes the opportunities for a higher education less equal (according to Romer, 1998) because an "external circumstance" like mobility cost, rather than own ability, becomes the main determinant of the students' human capital.