Using a model of rational student choice as its foundation, this study examined whether state policies toward higher education encourage junior colleges and universities to admit too many students. The optimal-size decisions of budget-maximizing junior colleges and universities were derived and compared to the optimal-size decisions of a social planner. Estimates were based on 1993-94 academic year data for average tuition, subsidy levels, and enrollments, along with average earnings by education status and graduation rates. These estimates suggested that junior colleges and universities behaved inefficiently by admitting more than the socially optimal number of students. The per-student subsidy levels that would be required to encourage both types of institutions to make socially efficient decisions were then determined. Finally, it was noted that government policies aimed at reducing the cost associated with transferring from a junior college to a university are demonstrated to improve the efficiency of the university system and worsen the efficiency of the junior college system. (Contains 20 endnotes.) (MDM)