Ecomnnrcs 01 Edrrurtiorr Rc~~irw. Vol. I?. No. -1. PP. 3X-31’). lYY3. 0272-7757/93 $6.(H) + 0.

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Printedin Grmt Britain. Pergamon Press Ltd

The Alchian-Allen Effect in Higher Education:

Public Versus Private Enrollment

CHARLES 0. KRONCKE, JR”’ and RAND W. RESSLER~

Department of Economics, Auburn University, 203 Business Building AL 36849-5242, U.S.A.;

+ Department of Economics and Finance, University of Southwestern Louisiana, USL Box 445-70, La
Fayette. LA 70504. U.S.A.

Abstract - Part of the full cost of participating in higher education is foregone employment. Increases
in the unemployment rate imply a lowering of foregone employment opportunities. This, in turn, lowers
the full cost of higher education. leading to an increase in the quantity demanded of such education.
When the distinction between public and private educational institutions is made, the Alchian-Allen
effect can be applied. Just as a shipping cost changes the price ratio of average to “good” apples
(Borcherding and Silberberg. 1978), fluctuations in the unemployment rate change the price ratio of
public to private education. Specifically. an increase in the unemployment rate implies that the price of
public education decreases relative to private education. This decrease should result in an increase in the
ratio of public to private enrollment. Our expectation is supported empirically by both time series and
more co&ncingl$. cross sectional results.

I. INTRODUCTION empirical findings. Concluding comments are in Part

V.
A FACTOR THAT plays a role in determining the
demand for higher education is the unemployment II. THE ALCHIAN-ALLEN EFFECT
rate. The unemployment rate serves as a proxy for
individuals’ employment opportunities in the The Alchian-Allen effect (1968) is the catch
market. A high unemployment rate implies a “tight” phrase given to the process of changing the relative
labor market and few employment opportunities. prices of two goods by changing the magnitude of a
Lower levels of employment opportunities reduce fixed cost the consumer must pay regardless of
the full cost of attending a college or university. The which of the goods is purchased. More formally,
opposite is also true; a low unemployment rate consider the price ratio P,/Ph, where P, is less than
implies a “loose” labor market and bountiful em- Ph. Furthermore, let c equal a fixed cost to be added
ployment opportunities. This, in turn, raises the full to both P;, and Ph. The ratio of full costs is cx as in
cost of post-secondary education. equation I.
In the absence of the public versus private
institutional dichotomy, an increase in the un- P;, + c
(y=- (1)
employment rate is expected to decrease the full Ph + c .
cost of post-secondary education; thus, causing an
increase in the quantity demanded of such edu- If c increases the value of (Y will increase. For
cation.’ The purpose of this paper is to reexamine example if P;, = 5. Ph = 10, and c = 5, then (Ymust
this expectation in the face of the Alchian-Allen be equal to 1011.5 (or 0.667). Now suppose c
effect once the distinction between public and increases to 10. This causes CYto increase to IS/20 (or
private schools has been made. Part II summarizes 0.75). As (Y increases, the relative difference be-
the Alchian-Allen effect, Part III applies this effect tween Pi, and P, decreases. A higher value of a
to the question at hand, and Part IV presents the implies that in relative terms, the more expensive
-
[Manuscript received I April 1992; revision accepted for publication I February 1993.1

345
346 Economics of Education Review

good has become more attractive to the consumer. decreasing foregone employment opportunities to
The opposite is, of course, also true. $15,000. Under these conditions, (-uHE = 16,840/
Probably the best known example in the literature 20,718 = 0.81282. Thus public higher education has
dealing with the Alchian-Allen effect was put forth become more attractive in t = 2 than in t = I. As a
by Borcherding and Silberberg (1978). This publi- result we should expect to see a higher public to
cation examines the question of why good apples are private enrollment ratio in t = 2 than in t = 1. This
shipped out of Washington, leaving only low quality expectation is tested in the following section using
apples for consumption within the state. The answer both time series and cross sectional data.
lies in the fact that after adding a shipping cost, c,
the price of the more expensive apples, Ph, becomes IV. EMPIRICAL MODELS AND FINDINGS
relatively more attractive. Thus, the value of (Y
increases. As a result, ‘good’ apples are a better buy In order to test if the Alchian-Allen effect
to out of state consumers than to in state “works” in higher education we develop a naive
consumers.’ time series model in which we view unemployment
rates (and their square) and average weekly income
III. PUBLIC AND PRIVATE as surrogates for foregone employment oppor-
HIGHER EDUCATION tunities. We employ both measures since they
capture two major aspects of the opportunity cost of
The Alchian-Allen effect can easily be applied to attending college; the unemployment rate is a
higher education. Suppose that the two goods in measure of the probability of (not) getting a job,
question are public and private educations.3 Tuition and weekly earnings is a measure of the extent of
levels of public and private institutions are P, and foregone income given that one works. Specifically,
Pb, respectively. Furthermore, let c be the cost of our model is:
foregone employment opportunities which can be
measured by the unemployment rate.’ The ratio of ENROLLMENT RATIO = y + p,
the full cost of public higher education to private (UNEMPLOYMENT) + Pr (UNEMPLOYMENT
higher education ((YHE) is as follows: SQUARED) + pi (INCOME). (3)

Public tuition + foregone employment Where ENROLLMENT RATIO = the ratio of

opportunities public enrollment to private enrollment at the
cvHE = (2)
Private tuitionforegone
+ national level, y = the intercept, UNEMPLOY-
employment opportunities MENT = the unemployment rate of the United
States,6 UNEMPLOYMENT SQUARED = the
Knowing that the unemployment rate has an inverse unemployment rate of the United States squared,
relationship to foregone employment opportunities, and INCOME = average real weekly earnings of
expectations can be formed regarding the impact of the United States. The data are compiled of the
changes in this rate on relative enrollment levels. years 1964-1988. All variables are in their natural
Specifically, an increase in the unemployment rate logarithmic form. The results are presented in
(which is analogous to a decrease in foregone Table I.
employment opportunities in equation 2) will make As shown in Table I, the unemployment rate does
aHE decrease. This implies that public higher have a positive and statistically significant impact on
education is relatively even cheaper than private the public to private enrollment ratio.
education than it was before the increase in the UNEMPLOYMENT SQUARED is included as a
unemployment rate. right hand variable in order to see if the magnitude
For example, let the cost of a public education be of the impact of UNEMPLOYMENT changes with
$1840 and let private tuition be $5718.’ In addition, changes in the level of UNEMPLOYMENT. This
suppose that at t = 1, foregone employment oppor- variable is negative but insignificant. Income effects
tunities can be quantified at $20,000. Under these are controlled for with the inclusion of INCOME as
circumstances, aHE = 21,840/25,718 = 0.84921. a regressor. The significance and positive sign of this
Now suppose that worsening economic conditions in variable indicates that income effects do play a
t = 2 increase the unemployment rate, therefore viable role in determining the enrollment ratio.
 The Alchian-Allen Effect in Higher Education 341

Table 1. Dependent variable: ENROLLMENT RATIO ment rate of each state squared, INCOME = per
r-values in parenthesis capita income of each state, FINANCIAL AID =
financial aid distributions of each state, TUITION
Regressors Coefficient estimates
RATIO = public tuition and fees/private tuition
Y -8.1563* and fees of each state, and POPULATION = the
-(2.038) number of people ages 18 to 24 in each state. The
UNEMPLOYMENT 0.2785** data are aggregated to the state level with each
(2.357)
state’ being an observation for fiscal years 1986 and
UNEMPLOYMENT SQUARED -0.0158
-(1.700) 1987. Once again, all variables are in their natural
INCOME 1.6134** logarithmic form. The results are presented in
(2.309) Table 2.
N 25 The coefficient of UNEMPLOYMENT is once
RZ 0.4564
5.89
again positive and significant lending additional
F
Durbin Watson 0.337 evidence of the Alchian-Allen effect in higher
education. The negative sign and significance of
** 0.05 level of significance. *O.Ol level of significance. UNEMPLOYMENT SQUARED imply that the
positive impact of UNEMPLOYMENT on
Specifically, increases in income have increased ENROLLMENT RATIO decreases with increases
enrollment at public institutions of higher education in UNEMPLOYMENT.
to a greater degree than their private counterparts. The coefficient of INCOME is once again positive
The results in Table 1 support the notion that the but the variable losses significance. This could be
Alchian-Allen effect does have an impact on due to the presence of another income-related
enrollment behavior in post-secondary education variable, FINANCIAL AID. This variable
even after income effects have been taken into measures the Department of Education’s obli-
account. gations for student financial assistance.x Financial
However, upon closer examination. the Durbin- assistance of this type appears to have a greater
Watson figure indicates that first-order autocorre- impact on private enrollment than on public enroll-
lation does exist in this model. When a corrective ment, as shown by the negative and significant effect
procedure is employed, both UNEMPLOYMENT FINANCIAL AID has on ENROLLMENT
and INCOME lose their significance. In addition, a RATIO. Finally, the state’s college-aged population
simple correlation matrix reveals a negative and
significant correlation between UNEMPLOY- Table 2. Dependent variable: ENROLLMENT RATIO
MENT and INCOME. Finally, the model presented r-values in parenthesis
in equation 3 is extremely simple due to data
Regressors Coefficient estimates
limitations. In order to address these empirical ________
shortcomings and to add further support to the time -0.5905
Y
series results obtained above, a more complete -(0.135)
model using cross sectional data is put forth in UNEMPLOYMENT 7.0689*
equation 4. (3.264)
UNEMPLOYMENT SQUARED -1.4551*
ENROLLMENT RATIO = y + -(2.584)
INCOME 0.1146
P,(UNEMPLOYMENT) +
(0.2318)
P,(UNEMPLOYMENT SQUARED) + FINANCIAL AID -0.3480**
P,(INCOME) + P,(FINANCIAL AID) + -(2.137)
fi,(TUITION RATIO) + P,(POPULATION), TUITION RATIO 0.0489
(0.255)
(4)
POPULATION -0.0751
where ENROLLMENT RATIO = the ratio of -(0.438)
public enrollment to private enrollment of each N 94
R’ 0.4939
state, y = the intercept, UNEMPLOYMENT =
F 14.212
the unemployment rate of each state, UN-
EMPLOYMENT SQUARED = the unemploy- ** 0.05 level of significance. *O.Ol level of significance.
348 Economics of Education Review

Table 3.

Definition Source
..~ _
Variables in Table I
ENROLLMENT RATIO The ratio of public to private enrollment at Digest of Education Statistics
the national level
UNEMPLOYMENT The unemployment rate of the United States Economic Repoit of the President
INCOME Average weekly earnings of the United States Economic Report of the President

Variables in Table 2
ENROLLMENT RATIO The ratio of public to private enrollment of each state State Higher Education Profiles
UNEMPLOYMENT The unemployment rate of each state Statistical Abstract of the United
States
INCOME Per capita income of each state Statistical Ahsiract of the United
States
FINANCIAL AID Financial aid distributions of each state Digest of Education Stati.vtics
TUITION RATIO Public tuition and fees/private tuition and fees of each State Higher Education Profiles
state
POPULATION Number of people ages 18 to 24 of each state Statistical Abstract the United
States

is controlled for by the inclusion of POPULATION so-called Alchian-Allen effect and applied this
as a regressor. As indicated in Table 2, this variable phenomenon to higher education. Specifically, we
is not statistically significant. have shown that when the magnitude of foregone
Since our data are cross-sectional, we may en- employment opportunities changes (as shown by the
counter some statistical inefficiency in our estimated unemployment rate), the relative full prices of
due to heteroscedasticity. This problem may be public to private higher education changes. This, in
mitigated to a large extent by the fact that our turn, changes the relative quantities demanded of
dependent variable, a ratio, is already deflated by a public and private educations.
‘size’ measure. However, since we pool our data for This argument is supported by both time series
2 years, we may still encounter problems due to and cross sectional empirical results. When the
.‘group-wise heteroscedasticity’ (where the groups public-private enrollment ratio is regressed against
are two-yearly cross-sections). We tested for this the unemployment rate (among other variables), the
problem using a Goldfeld-Quandt procedure coefficient of the latter is consistently positive and
(Gujarati, 1988). At the 0.05% level of significance the variable significant.
we are unable to reject the null hypothesis that no
heteroscedasticity is present in the model. Thus it
appears that the model in equation 4 does not
violate any of the standard statistical assumptions. Acknowledgements - The authors would like to thank
Richard Ault, John Jackson, Frank Mixon and two
V. CONCLUSION anonymous referees of this journal for helpful comments
on an earlier draft, but take responsibility for any
This paper has stated and formally put forth the remaining errors.

NOTES

1, This expectation is due to the substitution effect. In this paper, we are not concerned with the income
effect. Therefore, in our empirical analysis, income is controlled for by including it as a right-hand
variable.
2. Out-of-state consumers pay the price (P. or P,,) plus the shipping cost, c. In-state consumers pay only
the initial price (P., or P,,).
3. Alternatively, the Alchian-Allen effect could be applied to students choosing between in-state and
out-of-state institutions.
 The Alchian-Allen Effect in Higher Education 349

4. Note that we are implicitly assuming that the employment opportunities foregone of students of
public institutions are identical to those of students of private institutions. It is quite possible
individual data would indicate that typical students of private institutions have greater employment
opportunities than those who attend public institutions. However, because the data are aggregated to
the state and national levels we are unable to make this distinction.
5. These figures are the average tuition and fee levels in the United States for the fiscal years 1986 and
1987.
6. Both teenage and total unemployment rates were used. Because teenage rates resulted in a lower F
statistic, all results reported in Tables 1 and 2 employ total unemployment rates.
7. Alaska, Hawaii and Wisconsin are omitted due to data limitations.
8. Includes Pell grants, work study program funds, supplemental opportunity grants, state student
incentive programs, direct student loans and guaranteed student loans.

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