‘Competition Between Private and Public Schools, Vouchers and Peer Group Effects’ American
Economic Review 88, No. 1, pp. 33-62
Provides a model of ‘cream-skimming’ by private schools, modelling competition between public and private schools both with and without vouchers.
A school’s quality in this model is determined exclusively by the mean ability of its peer group (per-pupil spending is assumed to be equal in all schools).
Because able pupils bestow a positive externality on other students, private schools link the price they charge an individual to her characteristics (ability & income) by offering means-tested scholarships and bursaries.
This leads to the main theoretical result obtained by Epple & Romano - that, if an equilibrium exists, then it is hierarchical. The most expensive private school will attract the highest ability and highest income students. Then private schools of descending quality will divide up students of lower ability and/or income.
The public school(s) in this model act as a residual, taking in the poorest and least able pupils.
Introducing vouchers causes the number of private schools to increase.
Students who switch from public to private school as a result of vouchers definitely gain in achievement, though some may actually be made worse off (as the voucher reduces the quality of their outside option, the public school).
Students who remain in the public school, however, are made unambiguously worse off, as the quality of their peer group has fallen.
As schools do not respond positively to competition in this model, it is a pure model of cream-skimming.
