The Effects of Student Loans on the Provision and Demand for Higher Education

57 Pages Posted: 7 Nov 2017

See all articles by Rodrigo Azuero

Rodrigo Azuero

Inter-American Development Bank

David Zarruk Valencia

University of Pennsylvania - Department of Economics

Date Written: October 22, 2017


We characterize the outcomes of the tertiary education market in a context where borrowing constraints bind, there is a two-tier college system operating under monopolistic competition in which colleges differ by the quality offered and returns to education depend on the quality of the school attended. College quality, tuition prices, acceptance cut-offs and education demand are all determined in a general equilibrium model and depend on the borrowing constraints faced by households. Our main finding shows that subsidized student loan policies can lead to a widening gap in the quality of services provided by higher education institutions. This happens because the demand for elite institutions unambiguously increases when individuals can borrow. This does not happen in non-elite institutions, since relaxing borrowing constraints makes some individuals move from non-elite to elite institutions. The higher increase in demand for elite institutions allows them to increase prices and investment per student. As investment and average student ability are complementary inputs in the quality production function, elite universities also increase their acceptance cut-offs. In this new equilibrium, the differentiation of the product offered by colleges increases, where elite universities provide higher quality to high-ability students and non-elite universities offer lower quality to less-able students. We illustrate the main results through a numerical exercise applied to Colombia, which implemented massive student loan policies during the last decade and experienced an increase in the gap of quality of education provided by elite and non-elite universities. We show that the increase in the quality gap can be a by-product of the subsidized loan policies. Such results show that, when analyzed in a general equilibrium setting, subsidized loan policies can have regressive effects on the income distribution.

Keywords: Higher education, Student Loans, Education policy, Returns to Education, Labor productivity

JEL Classification: E24, I23, I24, I25, I28, L130

Suggested Citation

Azuero, Rodrigo and Zarruk Valencia, David, The Effects of Student Loans on the Provision and Demand for Higher Education (October 22, 2017). PIER Working Paper No. 17-020. Available at SSRN: or

Rodrigo Azuero (Contact Author)

Inter-American Development Bank ( email )

1300 New York Avenue NW
Washington, DC 20577
United States
2027018419 (Phone)


David Zarruk Valencia

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States

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