This paper compares the organisation of the university sector under private provision with the structure which would be chosen by a welfare maximising government. It studies a general equilibrium model where universities carry out research and teach students. To attend university and earn higher incomes in the labour market, students pay a tuition fee. Each university chooses its tuition fee to maximise the amount of resources it can devote to research. Research bestows an externality on society because it increases labour market earnings. Government intervention needs to balance labour market efficiency considerations — which would tend to equalise the number of students attending each university — with considerations of efficiency on the production side, which suggest that the most productive universities should teach more students and carry out more research. We find that government concentrates research more that the private market would, but less than it would like to do if it had perfect information about the productivity of universities. It also allows fewer universities than would operate in a private system.
