This piece is part three of a four part series. You can read the rest of the collection here.
The first report in this series on financial aid for students without financial need argued that most colleges cannot cover their costs without revenue from higher-income students. The second report showed that the practice of providing merit aid for students without financial need is widespread and growing, especially at public institutions, which traditionally did not offer this type of aid.
This report focuses on the strategies colleges use to set prices. How do colleges set sticker prices and how do they choose how much to discount that price for students without financial need by offering merit aid? Over time, how have prices changed as market conditions evolved?
More on how colleges set prices
The market for college is different from that for many other products in that different students pay different prices. Colleges set a maximum price (the sticker price) and then determine which students will receive discounts in the form of financial aid. Those discounts may or may not be based on financial need. In this series, I focus on price-setting for higher-income students who can afford to pay the “sticker price” according to the financial aid formula.
The sticker price reflects the maximum tuition a student will have to pay for a particular college, as published by the college itself. Some students may be willing to pay more than that amount. If so, colleges have an incentive to charge them more by raising the sticker price. Others willing to pay less would be offered a discount so that the net price is aligned with how much they are willing to pay. In economics, this is an example of a concept unfortunately labeled “price discrimination.” This approach to pricing can benefit lower-income students, since the federal government and many colleges offer them need-based financial aid, which reduces their net price and improves access.
A higher sticker price allows colleges to raise more revenue from higher-income students, but only to the extent that no offsetting discount is provided. A high sticker price may also send a message about institutional quality. As shown in the preceding parts of this series, many colleges offer discounts to higher-income students in the form of merit awards. In addition to reducing the net price that students pay, merit awards may provide a psychological bonus that makes students feel valued by the college, both of which can encourage enrollment.
Colleges often prefer to maintain a high sticker price while offering targeted discounts rather than reducing the sticker price for everyone. A lower sticker price would limit institutions’ ability to charge higher prices to students who are willing to pay more. It may also weaken the marketing value conveyed by a higher posted price along with a merit award.
The level of the sticker price, the extent of discounting, and the size of enrollment together determine how much total revenue a college raises from higher-income students. Institutions aren’t necessarily setting prices to maximize profits as we might expect from a for-profit business. But even as nonprofit organizations that have broader social goals, they still must generate sufficient revenue to cover their costs. How they set the sticker price and what discount they offer to which students are levers they can pull to affect how much revenue they raise from students.
What happens if costs rise or, at public institutions, state support declines? The cost of running a college, even without changing the level of services or facilities, has increased faster than inflation.1 In addition, students’ demand for more services and nicer facilities can also increase costs. Many public institutions saw meaningful declines in public funding per student following the Great Recession. That funding has rebounded but still lags rising costs.
These pressures generate the need for additional revenue. Enrolling more higher-income students who can pay more, even if it is less than the sticker price, can help satisfy that need. Because students without financial need also tend to have higher academic achievement, they often have many options for where to attend college. Institutions must compete for them. One way to do that is to offer them discounts so that the net price is below the sticker price.
Public institutions that enroll more out-of-state students offer more merit aid
An example of this dynamic—where colleges use merit aid to attract students who can pay higher prices—is evident at public institutions facing financial pressure. Out-of-state enrollment has increased substantially, especially at public flagship/R1 institutions. Figure 1 shows that out-of-state enrollment at these schools increased from 16% of undergraduate enrollment in 1997-98 to 24% in 2024-25. Other public institutions also enrolled more out-of-state students over this period, but the level and the increase are much smaller.
Some research shows that financial pressures contributed to this trend. That study does not identify the specific mechanism institutions used to attract students from other states, but price discounting is a plausible strategy that is consistent with the pricing framework described earlier.2
There is no definitive way to link the increasing enrollment of these students to the practice of discounting the prices of out-of-state students, but my analysis provides suggestive evidence supporting that idea. First, the increased enrollment of out-of-state students in the later part of this period occurred concurrently with the growth in merit aid at these institutions documented in Part 2 of this series. Second, if financial pressures drive institutions to use merit aid to recruit out-of-state students, a positive correlation should emerge between out-of-state enrollment and the share of non-needy students receiving aid.3 Figure 2 shows this is the case.4
The link between international student enrollment and providing merit aid is weaker
Similar to the out-of-state enrollment strategy, colleges might also try to enroll more international students to increase revenue, and they may need to offer discounts to attract them. This strategy is potentially available to both private and public institutions. However, an analysis similar to Figure 2 does not find a positive correlation between the share of students with no financial need and international student enrollment (see Appendix Figure 1).5 In fact, it appears to be the opposite pattern. One interpretation of these findings is that international students are drawn to institutions with sufficiently strong finances and reputations that they do not need to rely as heavily on discounting to attract students without financial need.6
Does more discounting to no-need students affect students with financial need?
When colleges introduce or expand discounts for students without financial need, they may increase revenue in the short run. However, once one institution adopts this strategy, others may follow. As more colleges offer similar discounts, any price advantage, along with the associated revenue gains, may disappear. Institutions may find themselves in a continual cycle of expanding those discounts to gain additional short-term revenue.
Eventually, institutions may find themselves in a position where most or all students without financial need receive discounts. Private, tuition-dependent institutions already appear to be approaching this situation: Almost two-thirds of colleges in that category provide merit aid to nearly all students without financial need (see Part 2). More broadly, in the longer run, most of the additional revenue from higher-income students may be “competed away,” as institutions offer larger discounts to enroll a limited supply of higher-income students such that their budget balance doesn’t improve or even deteriorates.
While increased use of merit aid benefits higher-income students by reducing their net price, it can strain institutional finances. Institutions may then be forced to make cuts in the academic program or student services that may make it even harder to recruit higher-income students. It may also limit colleges’ ability to enroll lower-income students and offer them affordable prices. The gap between what those students can afford to pay and the cost of their education is often substantial. Revenue from higher-income students often helps fund need-based aid for lower- and middle-income students.7
From pricing patterns to policy questions
The economic incentives colleges face have been pushing them to expand discounts for students without financial need while posting high sticker prices. One clear casualty of this approach is price transparency. Because sticker prices are highly visible and information about financial aid is limited, even higher-income students often cannot know what they will actually pay to attend a particular college.
This situation also has implications for institutional finances. As colleges increase discounting and price competition intensifies, they are likely to collect less revenue from higher-income students overall. This is beneficial for those higher-income students, but it may create financial problems for institutions. For institutions without alternative sources of funding to fill the gap, access for lower-income students could suffer. Part 4 of this series discusses potential approaches to address these challenges.
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Footnotes
- I will return to this in part 4 of the series.
- Increasing total enrollment is another strategy to increase revenue. At least initially, enrolling more students increases revenue at relatively low cost, but crowding costs may grow as enrollment increases grow larger.
- An important limitation of this analysis is that the data cannot separately identify in-state and out-of-state students when measuring financial aid awards. The analysis links the overall share of out-of-state students to institutional pricing patterns but cannot determine which specific students receive merit aid.
- The categories defined on the horizontal axis were set to roughly equalize the number of institutions included in each category. A limitation of this analysis is the inability to distinguish whether discounted students lived in the state or in other states. This contributes to the conclusion that these results are purely suggestive.
- This analysis focuses specifically on private colleges and universities with at least large endowments and public flagship/R1 institutions because these are the categories that enroll the largest share of international students (see Appendix Figure 2).
- This is consistent with the pattern in Appendix Figure 2, which shows that highly endowed private colleges enroll the largest share of international students.
- This is a form of cross-subsidization. But as I showed in Part 1, students with no financial need do not pay more than average core educational expenses at public flagship/R1 institutions or private institutions with large or very large endowments. Other sources of revenue must be available to fill in the budget gap at those institutions.
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