Institutions of higher education comprise knowledge creation (research) and knowledge dissemination (teaching). Thus, the university's mission is to deliver quality undergraduate and graduate education and to expand the frontier of academic research. Numerous studies (Verry and Layard 1975; Cohn, Rhine, and Santos 1989; deGroot McMahon, and Volkin 1991; Nelson and Hevert 1992; Lloyd, Morgan, and Williams 1993; Dundar and Lewis 1995; Koshal and Koshal 1995, 1999) have investigated, as in the case of firms, the multiple-product cost function of producing the vector of outputs on undergraduate and graduate education and research. The cost structure of higher education is studied via the scale economies and the scope economies of the cost function. However, these measures of scale and scope economies may be elusive if the quality dimension of colleges and universities is not considered. Without taking into account the quality variation, in the short-run, a university can reduce the average cost of operation by lowering the quality. Universities with more congested educational facilities are substituting facility utilization for capital; universities with a higher student/faculty ratio and less research engagement are substituting quality of education for quantity of undergraduate and graduate enrollment. The consequence is an upward bias in estimating the economies of scale and scope. This conclusion is consistent with the early studies of Nelson and Hevert (1992) which showed that failure to control for class size in cost function may result in specification bias, and an economy of scale is evident if class size is allowed to expand.
Quality of higher education is multidimensional. Quality in instruction, faculty research, and the quality of educational environment are all significant factors determining the long-run university cost structure and the crucial determinants of the scale and scope economies of higher education. How and to what extent quality affects a university's operating cost depends on the goal and orientation of the institutions. Higher quality increases the university's cost of operation. But, in a large research-oriented university, a disproportional share of the budget often benefits the graduate, not the undergraduate program. It is unrealistic to assume that quality affects only the average cost and that the marginal costs of various educational programs are independent of quality. Quality is unlikely to be simply a neutral cost-shifting factor.
The purpose of this paper is to propose a university cost function and a semiparametric-estimating technique that treats quality as a nonneutral cost-shifting factor, which directly affects the marginal cost of outputs in undergraduate and graduate education. More precisely, the marginal costs of outputs are specified as a nonparametric smooth function of quality. A semiparametric specification of university cost is applied to 56 comprehensive and science/technology universities in Taiwan over the period 2000-2003.
II. SEMIPARAMETRIC COST FUNCTION AND ESTIMATION TECHNIQUE
Following the conventional multiproduct cost specification for higher education (Cohn, Rhine, and Santos 1989; deGroot, McMahon, and Volkin 1991; Lloyd, Morgan, and Williams 1993; Dundar and Lewis 1995; Koshal and Koshal 1995, 1999), the total cost (C) is specified as a quadratic function of outputs, undergraduate and graduate enrollments. However, the quadratic cost function is modified by allowing for the coefficients to be functions of quality in the following form:
(1) C = [[beta].sub.0](Q) + [k.summation over i=1] [[beta].sub.i](Q)[Y.sub.i] + (1/2) X [k.summation over i=1], [k.summation over j=1], [[beta].sub.ij](Q)[Y.sub.i][Y.sub.j] + [m.summation over i=1], [[alpha].sub.i][Z.sub.i] + [epsilon]
where C is the total cost of producing k educational outputs (Y), and [Z.sub.i] is the ith institutional characteristics. …