If you wanted to spend $500,000 to encourage the emergence of bitcoin in a "market" like MIT, I think it would be more productive to use the USD like a traditional subsidy: Pay MIT merchants to offer discounts on BTC-based sales. If I'm spending $40/week at LaVerde's, a 10% discount might be enough to get me to convert a few hundred dollars of my own money into BTC.
As it is, the project will have to deal with getting merchants set up to accept BTC anyway, and my bet is that most students will be content to sit on their BTC hoping for another price spike rather than go through the trouble of learning how to use it for everyday transactions.
It would be beneficial to Bitcoin if more people were to buy some and sit on it. Right now the market cap is only around 5 Billion. If BTC is going to realize the promise of making transactions easy then the total market cap needs to be large enough to absorb large buys and sells w/o causing huge movements in the price.
You want transaction volume, not total value outstanding, to help a market absorb larger transactions. The impact of a particular trade on a market is determined by the amount of trading going on (in particular, the size of the unfilled bids and the depth of the bids -- how much is available to trade, and how far away from the current market price is each potential trade.) At its most simple this is represented by the bid/ask spread, the gap between where you can buy and sell at a given moment - in more liquid markets, this gap is smaller.
Generally, a market where there are lots of transactions going on is going to have a bigger set of bids and asks right near the most recent transaction price. If a market is thin, than a large sale, for example, might have to chew through a lot of bids and push the price way down to get done.
large buys and sells will cause huge movements in thinly traded markets in which people "buy some and sit on it" (ie don't engage in transactions). I don't understand what you're getting at?
False. A large buy order in a market without many trades will look large, no matter how large the bank accounts are. If you have a market with each participant holding onto $10M, but doing only a few $1 trades per day, a $10,000 trade will be large.
As it is, the project will have to deal with getting merchants set up to accept BTC anyway, and my bet is that most students will be content to sit on their BTC hoping for another price spike rather than go through the trouble of learning how to use it for everyday transactions.