Some Observations on the Allocation of Resources in Higher Education

Abstract

PpTHERE exists some sentiment to the effect that economic analysis is an inappropriate discipline to apply to the study of higher education. This sentiment exists, I believe, because of a misunderstanding on the part of those who share it of what the economist takes his objectives to be. Let me try to state briefly what these objectives are and what they are not: the economist does not want to channel resources away from higher education by cutting costs per se. Rather, he is simply interested in achieving what at a high level of generality may be called the of available resources within the framework of values that the administrators have established. Thus the problem to be considered is an allocation of resources problem. Having recognized this fact we would do well to remind ourselves first of the purpose and then of the general principles of investment theory. From the viewpoint of an administrator the purpose of investment theory is to present criteria which will enable him to determine how to allocate his institution's resources. Ideally, the proper use of these criteria shows the decisionmaker how to allocate his resources in such a way that the gap between his ideal objectives and his real achievements is as small as it can be under the existing conditions. What then are the criteria which have been established in traditional investment theory? The two most widely considered concepts are the present value criterion and the marginal returns criterion. The present value method is applicable to a situation in which the decisionmaker must choose between two alternative investment outlets because he has enough capital to undertake only one of them. The present value criterion thus answers the question, Which one? The decision is made on the basis of a present value calculation; the project whose discounted present value is greater is pursued. The marginal returns criterion is applicable in a different type of situation. It is used where the alternative investments do not require any one specific quantity of capital but rather where it is possible to make use of varying amounts of the output from each investment. The situation no longer involves an all-or-nothing decision; rather it is a substitution problem. Thus, whereas the present value criterion answers the question, Which one? the marginal returns criterion answers the question, How much of each one? It tells the decision-maker to allocate his capital between any two investment outlets in such a way that the returns on the last unit of capital placed in each outlet are equal. For, if the returns on the last unit placed in the first outlet exceed the returns on the last unit placed in the second outlet, the total returns can be increased by transferring units of capital from the second to the first investment. It is clear then that the total returns will be maximized only when the returns on the marginal or incremental unit are the same in both outlets. From the viewpoint of a college administrator the interesting question is this: to what extent can the present value and the marginal returns calculations help to achieve the proper allocation of resources within an educational institution? I would suggest that these criteria are useful conceptually, but that in their present form they cannot give definitive and quantitative answers to the questions, Which one? and How much of each one? This conclusion is, in itself, hardly surprising. It is, however, useful, for by explicitly spelling out the reasoning which leads me to it I hope to accomplish two aims: first, I hope to point out some of the fundamental issues involved in the allocation of resources in education, and second, I hope to lead up to the subsequent development of the specific allocation criteria for education which I advocate below. Why then are these two criteria of limited usefulness? The answer to this question can best be understood if we compare the educational institution to the theoretical business