Peer Group Effects in Applied General Equilibrium

Abstract

In this paper, I analyze private school formation and composition, when a student's educational achievement depends upon the student's type and the school's peer group and per student expenditures. I develop applied general equilibrium techniques to find equilibrium consumption and schooling structure, in the presence of peer group effects. I find that, depending upon the specification of the technology which converts these inputs into educational achievement, a variety of outcomes can arise in equilibrium. For example there can be segregation or mixing across schools, or a combination of both. Lastly, I consider the welfare and distributional effects of three policy changes. I show that equalizing expenditures across schools reduces the range and the standard deviation of the distribution of human capital, as does forcing certain forms of integration. Both policies imply a welfare loss. I also study a voucher system. Implementing such a policy is welfare improving, given the specification of the utility function chosen here.