Every once in a while I get the urge to write about economic issues that have nothing to do with trading.  There’s been a lot of online discussion recently about the value and cost of college.  My personal take on this is that college is very valuable if you choose an institution and major which teaches something you want/need to know and then put in a reasonable level of work.  Without at least my undergraduate computer science degree, I’d be much worse off in terms of both my engineering career and my trading.  That said, I feel the cost of college has spiraled out of control at many institutions.  There are lots of reasons for this, but I believe reason #1 is that would-be students and their parents are horrible shoppers.  They have no idea what various college services ought to cost, so they have no idea what they ought to be paying.  All they know is vaguely what they want to buy.  This is analogous showing up at the car dealership knowing you “want something nice” but having no idea what any of the cars ought to cost, and being determined to buy something no matter what.  It’s not hard to see how such an auto shopper would get totally screwed.

I figured I’d do my little part to rectify this problem.  The relevant question, to my mind, is this: what does it cost to re-create a top notch college education on the open market?  In order to answer this question, we need to break it down by categories:

• Physical plant: In any reasonable location, $500K in physical plant (buildings, computers, books, etc.) per 10 students should represent the lap of luxury.  In reality much less would be adequate, but we’re trying to price a top tier education here.  Note: this covers only physical plant for education, not rooming.  Assuming a 5% cost of capital and 5% cost of maintenance/replace (both annual), this translates to $5,000 per student per year.
• Professor Labor: Assume the average student takes 4 classes, and a professor can teach 2 classes per semester.  The number of professors needed per student is then (2/class size).  If we assume a professor costs $150,000 per year in salary and benefits (which will get you an above average prof – the average PhD makes about $75K in sallary) then total per-student cost is $300,000 divided by average class size.
• Grading/TA/secretarial labor: For simplicity sake, figure this adds an extra 10% on to the professor costs.  Total labor costs are now $330,000 divided by average class size.
• Administration and paper pushing:  Figure one administrator per 10 profs and that they’re paid the same lofty salary.  Now labor is $360,000/class size.

Now, there’s certainly other things that go on at colleges – drinking, the greek system, sports programs, etc.  But the above list is all that’s required to get an education.  The final  cost formula looks like this:

A top notch college education costs $5,000 + ($360,000 / class size) per year (2012 dollars) to re-create on the open market.

With this information in hand, you can compare what a school offers to what it costs.  For example, my undergrad education cost $13,000 per year in tuition adjusted to current day dollars.  The average class size was about 25.  The cost, per formula, should have been $19,400.  But I went to a state school and didn’t get quite the gold plated facilities described above, and a few classes weren’t taught by PhDs.  Say I got 70% of the value described above.  That would set the expected cost at $13,580.  I’d say I got what I paid for almost exactly.

Contrast Harvard, which charges $38,480 in tuition.  We won’t de-rate their value at all since Harvard really is gold plated.  But they’re still almost $20,000 more expensive than the cost of buying the same thing in pieces on the open market.  In order to justify that cost, they’ve have to have 13 person classes and double gold plated facilities.  That’s just not reality.  For all of Harvard’s vaunted endowment, in reality they overcharge the undergrads horribly.

Hopefully you can use this formula to cut through some of the college cost bullshit, and understand if you’re really getting what you paid for or not.