Educational Inequality and Reservation Policy in Developing Markets

Abstract

Educational inequality undermines the pivotal role of education in increasing the ability of the poor to move up the income ladder. This paper investigates educational inequality that arises from low-income students' lack of monetary resources that higher-income students invest in college-admissions-test preparations. We show educational inequality increases in the size of higher-income students and in the selectivity of college admissions. The intuition is that a larger size of higher-income students makes the college admission more selective and thus the college education more rewarding. All students study harder. However, because higher-income students' efforts are more effective, due to their monetary investments in test preparation, they respond more aggressively. Therefore, the probability of admission of a higher-income student becomes even higher than that of a low-income student. In the context of developing markets, we study implications of a reservation policy that aims to reduce inequality by transferring seats to students of certain identifiable characteristics that are imperfectly informative of students' lack of monetary resources. We show such a transfer, if small, can enhance student welfare. However, a large transfer may reduce student welfare.