Friday, July 8, 2011

College Education & Opportunity Cost

In terms of rate of return, investing in a college education beats most alternatives, including the stock and bond markets. According to a recent Brookings research paper  (see Brookings paper), investing in a college education yields about a 15% annual internal rate of return.                              

This article provides a nice example of opportunity cost. Opportunity cost is a key concept in economics, but it is often poorly understood. Imagine you are at a decision point in life, a fork in the road. You can think of "opportunity cost" as the value of the road not taken. More formally, opportunity cost is the value of the next best alternative.  The opportunity cost from going to college is the foregone earnings you could have earned ($54,000).

Sometimes students have a hard time seeing foregone wages as a real cost. Suppose you decided not to go to college. You wouldn't fork over $48,000 for tuition and fees and you would pocket $54,000 from earnings. You would be $102,000 richer than your friends on the day they graduate from college.  Your friends would have forfeited their $102,000 to go to college.

Table based on Brookings paper, see NCES for tuition data

Note that the opportunity cost ($54,000) for a typical high school student is greater than the tuition cost at a 4 year college ($48,000). The tuition costs do NOT include room and board, since people must eat and sleep whether they work or go to school.  For most people, the gain in income from college ($570,000) far exceeds the combined costs of tuition and foregone earnings.

Admittedly some people, like Kobe Bryant, have a special talent that allows them to earn a huge salary without going to college. For these people, the opportunity cost of college is in the millions, and they are much less likely to go to college.  While some of the uber-talented still do go to college (think of starlets like the actress who played Hermione Granger), they presumably place a lot of value on the social, intellectual benefits of college and have a flexible earning schedule.  For the rest of us ordinary mortals, the 15% rate of return on a college education should be too good to pass up, especially when all the non-monetary benefits are considered.

For a note of caution on students loans and making sure you get something useful out of college, watch:
Returns for a full-time MBA also look good. Davies and Cline (2005) estimate that the internal rate of return on  a MBA was 18% and the average payoff time was about 9 years (time until extra earnings from MBA covered tuition and foregone earnings). The rate of return may actually be lower for top 10 MBA programs due to greater costs (see reference for Grady below for literature review).

For EMBA students, you may already know that EMBA students' responses on surveys usually show more satisfaction with their MBA program than part-time or full-time MBA students. Since EMBA students do not forgo earnings, their payoff time is much quicker, closer to 4 years.

 (1) Bruce, Grady (2010), Exploring the Value of MBA Degrees: Students’ Experiences in Full-Time, Part-Time, and Executive MBA Programs, The Journal of Education for Business, 85(1): 38-44. or 

(2) Executive MBA Council, Research on Return on Investment


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