Financial aid in college admissions: need-based versus merit-based

In college admission, financial aid plays an important role in students’ enrollment decision as well as their preparation for college application. We analyze how different types of financial aid affect these decisions and admission outcomes. We consider two financial aid regimes—need-based and merit-based—in a simple college admission model and characterize respective equilibria. We find that a more competitive college has a higher admission cutoff under a need-based regime than under a merit-based regime. A less competitive college, on the other hand, benefits from a merit-based regime as it admits students with a higher average ability than it does under no aid. We next allow colleges to choose their own financial aid system so as to account for a stylized fact in the US college admissions. We show that when one college is ranked above the other, it is a dominant strategy for the higher-ranked college to offer need-based aid and for the lower-ranked college to offer merit-based aid.