Effects of consumer mistakes on the market for higher education

Based on the literature in behavioral industrial organization, this thesis presents a model of consumer mistakes on the market for higher education. The mistakes considered are overestimating future earnings as well as not taking into account the possibility of dropping out. Inefficiency can arise, when consumers naive about their earning potential purchase a contract for education and their actual lifetime gain (over not having education) is less that the opportunity cost of the time spent studying. Also, in the monopolistic model, naivete can cause the college to charge a higher equilibrium price, than in the model without naivete. In a competitive model there can occur a cross-subsidy effect, in which students, that do not face a risk of dropping out, pay tuition price below the marginal cost of their education. This works through the college front-loading the tuition cost to the time before a fraction of students with that risk drop out.