Full Solution of an Endogenous Sorting Model with Contextual and Income Effects

Abstract

The paper solves themselves into neighborhoods because they value average schooling among adults in the neighborhood. The paper extends results by Nesheim (2002) but with the addition of income effects on neighborhood choice. Individuals value housing, non-housing consumption, and expected schooling of their children. The latter depends on parental schooling, on a child's ability, and on average schooling in the neighborhood. Neighborhood choice trades off non-housing consumption with children's expected schooling. Individuals choose neighborhoods recongnizing that their neighbors' characteristics are correlated with their own. The equilibrium housing price is associated with endogenous sorting and also allows computation of a neighborhood distributions of income, schooling and other variables of interest.