What do kittens have to do with rising tuition?Posted: March 8, 2013
If you read the Financial Times, you might suspect from an article on Monday that kittens have something to do with rising tuition and Prisoners’ Dilemmas. Let me assure you that they don’t.
A friend of mine sent me the article, which cites a model designed by a team of Bank of America consultants who use the Prisoners’ Dilemma to explain rising college tuition. Here is the graphic they used:
Fig. 1: Things that are pairwise irrelevant to each other:
a kitten, the Prisoner’s Dilemma, and rising tuition.
They explain that the college ranking system (assuming two colleges) is a zero-sum game. If one college moves up, the other one moves down. “A college can move up in the rankings if it can raise tuition and therefore invest in the school by improving the facilities, hiring better professors and offering more extracurricular activities.” And therefore, they conclude, this is why college tuitions have been rising and why student debt will continue to rise.
First glaring problem: (raise, raise) is a Pareto-optimal outcome as they’ve set up this game, but what they probably meant to say was that it is a Nash equilibrium. Or maybe they meant to say that “raise” is the best response for each college. Anyway, in this game, (don’t raise, don’t raise) is also Pareto-optimal (but not a Nash equilibrium)!
Secondly, they’re trying to illustrate a kind of ratcheting problem: both colleges raise tuition to raise the quality of the resources at the school, in order to maintain their rankings. But, this means it’s a repeated game. In repeated games that have a finite horizon, defection happens at every step, but at infinite horizon games, cooperation can occur. Now, let’s just assume that this is an infinite horizon game, which is what the folks at B of A are assuming when they predict that college tuition will keep rising indefinitely, beyond mere inflation. What incentive is there to cooperate and keep tuition low? According to this game, none. And according to what you might expect in reality, none – is it plausible that, in the absence of antitrust laws, that colleges would want to collude to keep tuition low, and that because they can’t collude, they are doomed to raise tuition every year against their wills? Nope.
Then, we come to the matter that in fact this game can’t be infinite horizon as it is presented here. The simple reason is that, even if education is becoming a larger and larger share of a household’s spending, and even if the student is taking out loans and borrowing against his future expected earnings, he still has a budget set that he can’t exceed. Furthermore, the demand for attending college at a particular university should drop as soon as the tuition exceeds the expected lifetime earning/utility advantage for whatever the student sees himself doing in 4 (or more) years over the alternative. So, there will be some stage at which the utilities change and it becomes a best strategy for neither school to increase its tuition. So, it’s a finite stage game and the increase will stop somewhere, namely, where price theory says it should. 
Finally, it’s not clear that increasing tuition actually has such a strong effect on school rankings or that colleges are in such a huge rankings race. And, even if students at colleges outside the very top schools tend to choose a college based on things like food quality and dorm rooms, students don’t demand infinitely luxurious college experiences at infinite prices. Evidence: Columbia students feel they’re overpaying for food, and feel entitled to steal Nutella.
The lessons here are these: It’s not a Prisoner’s Dilemma in a strong sense if the cooperative result isn’t strictly preferred to the Nash equilibrium. Don’t model a tenuous game where the game isn’t relevant to the ultimate result (tuitions will stop rising at some point). Don’t assume that trends are linear, when they are definitively not linear. And, don’t put a kitten on your figure just because you have some white space — it really doesn’t help.
 Actually, the game doesn’t have to be finite horizon. Suppose the upper limit that the colleges know they can charge is , and the current tuition is . Then, at each stage, they could increase tuition by . But, as the tuition approaches A, the increases become smaller and smaller until they pretty much just vanish, and it would be the same as stopping, because there is a time at which the tuition would stop affecting rank (a college isn’t going to improve it’s rank by charging each student an extra cent.)