Producing the Right Pond: Colleges as Network Creators

In many economic contexts, especially signaling and search models, agents care about the distribution of other agents around them. Because of this, firms arise which produce neither goods nor services, but local “ponds†of agents. Such firms derive their attractiveness through the desires of their customers to be associated with each other. In order to be successful, these firms need to be able to exercise control over who their customers are. Colleges fit nicely into this category of firm because they are able to construct specific distributions of students by offering scholarships to desirable students, while charging very high prices to others. I build a simple model of price competition among such firms, deriving the demand for fellow customers from signaling and search microfoundations. The model offers predictions of how various proposed education reforms might alter the distribution of students among colleges, and provides a simple structure which may be easily adopted for the purposes of estimation