Anderberg & Andersson (2007) - Stratification, Social Networks in The Labour Market, and Intergenerational Mobility

The Economic Journal, 117 (April), 782812. The Author(s). Journal compilation Royal Economic Society 2007.
Published by
Blackwell Publishing, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.
STRATIFICATION, SOCIAL NETWORKS IN THE LABOUR

MARKET, AND INTERGENERATIONAL MOBILITY*
Dan Anderberg and Fredrik Andersson
Young individuals, taking the locational choices made by their altruistic parents as given, decide
whether or not to acquire skills. The use of location-specific word-of-mouth communication in the
transmission of information about (skilled) job opportunities implies that the local social environ-
ment partly determines an individuals expected returns to education. Stratified equilibria, when
they exist, are characterised by low intergenerational social mobility and inefficient use of talent. In
addition, the equilibrium responses to factors that generally encourage education may, in stratified
outcomes, be highly asymmetric across socio-economic groups. Non-stratified equilibria are likely to
be destabilised by measures that encourage education.
Recent decades have seen a pronounced increase in inequality in many countries,

along with increasing wage returns to education. The increase in the returns to skill has
encouraged participation in education. The response, however, has not been uniform
across income groups. In the UK for example, the participation rate in higher edu-
cation has more than doubled over the last twenty years; this general expansion has
been accompanied by a strengthening of the education parental income relationship,
with participation in higher education rising much faster in the higher income groups
than in the lower income groups (Blanden and Machin, 2004; Blanden and Gregg,
2004). A similar development is manifest in the US; while there was a substantial
increase in college attendance in the 1980s, the increase was much smaller among
children from poor families than among children from rich families (Ellwood and
Kane, 2000; Acemoglu and Pischke, 2001).1 The uneven responses imply that further
increases in inequality may be looming, and gaining an understanding of the causes of
the asymmetric responses is of great importance if appropriate counteracting policies
are to be designed.
The traditional economic model linking parental income to childrens educational
outcomes is the parental investment model associated with Becker and Tomes
(1986).2 A key feature of the Becker-Tomes model is, however, that parental income
will only matter for investments in children if parents are credit constrained. Whether
investments in education are directly and significantly affected by credit constraints is
unresolved in the empirical literature. Cameron and Heckman (2001) and Carneiro
and Heckman (2002) however present convincing evidence against the presence of
widespread liquidity constraints affecting post-secondary schooling, pointing instead to
the role played by ability. Overall, these studies suggest that family background plays a
* We thank the Editor Marianne Bertrand and two anonymous referees for excellent comments and
suggestions. The usual disclaimer applies.
1
The same phenomenom is reflected in the intergenerational social mobility literature where it has been
noted that, at least for the UK, intergenerational correlation in earnings seems to have increased over time
(Blanden et al., 2004). For US evidence, see Mayer and Lopoo (2005).
2
See also Loury (1981).
[ 782 ]
[APRIL 2007 ] STRATIFICATION, SOCIAL NETWORKS AND MOBILITY 783
role through its long-run effects on childrens development including cognitive skills,
not through short-term liquidity constraints.
Relatedly, there is a growing literature that seeks to identify the effect of family
income on childrens educational attainment. This literature uses a variety of methods
in order to give the results a causal interpretation, including siblings approaches,
(randomised or natural) experiments, and IV methods.3 A frequent finding in this
literature is that, once more sophisticated methods are used in order to obtain a causal
interpretation, the estimated effect of family income on childrens educational
attainments is significantly reduced relative to standard OLS estimates.
In contrast the results from the Moving To Opportunity (MTO) programme indicate
significant improvements in child outcomes (Katz et al., 2001). In these programmes a
random selection of families receive financial support to meet higher housing costs
associated with moving to more affluent areas. What is interesting about these pro-
grammes is that their observed effect should be due purely to neighbourhood change,
hence pinning down the local social environment as a key channel through which
family income affects childrens outcomes.4
One upshot from these findings is that there is a potential usefulness of economic
models that explicitly link parental income to childrens educational outcomes
through the channel of local social environments. By explicitly modelling local social
interactions and equilibrium locational choices such models may well produce quite
different predictions from the predominantly atomistic approach used in the Becker-
Tomes model. This insight has spawned a growing theoretical literature that looks at
the causes and consequences of endogenous segregation when the social environment
(i.e. the neighbourhood) affects the human capital accumulation process. Models in
this literature can be broadly partitioned into three groups:
1. Models that follow the Tiebout tradition by modelling local public finance
of education (Fernandez and Rogerson, 1996; Benabou, 1996; Durlauf, 1996).
2. Models with direct human capital externalities or peer group effects (de
Bartolome, 1990; Benabou, 1993, 1996; Durlauf, 1996).
3. Models where neighbourhoods act as social networks (Streufert, 2000;
Moizeau et al., 2004).
The main methodological difference between the second and third class of models is
that while the last class tries to provide microfoundations for neighbourhood effects
the second class treats the externalities as primitives. The current article falls into the
third group, but stresses a mechanism that has hitherto not been explored in the
context of inequality of educational outcomes, namely the role played by the local
social environment in job search activities.5
3
Blow et al. (2005) provide a survey of methods and findings. See Shea (2000) for an example of an IV
approach, Levy and Duncan (2001) and Duncan et al. (1998) for siblings analyses, and Clark-Kauffman et al.
(2003) for an example of randomised experiments approach. See also Blanden and Gregg (2004) for a
discussion of these methods and applications to UK data.
4
There is also an empirical literature that seeks to determine the role of neighbourhood characteristics
(e.g. average local income) on a variety of childrens outcome variables. Examples include Case and Katz
(1991), Brooks-Gunn et al. (1993), and Ginther et al. (2000).
5
An alternative role of neighbourhoods is in providing information through which youngsters form beliefs
about the likely return to educational investments. Models of this type are provided by Streufert (2000) and
Moizeau et al. (2004).
The Author(s). Journal compilation Royal Economic Society 2007

784 THE ECONOMIC JOURNAL [APRIL
Empirically it is clear that social contacts play an important role in the job search
process. Montgomery (1991) notes, for instance, that about between 24% and 74% of
workers in the US, depending on industry, report having found the jobs through
friends and relatives.6 From a cross-country point of view, the structure of the flow of
information in labour markets can be expected to differ; public employment agencies,
for example, appear to play a smaller role in the US than in many European countries.7
Legislation also varies across countries; an extreme case is Sweden where employers
are, in order to facilitate job-search, required to notify the National Labour-Market
Board about any vacancies created, suggesting that comparatively few jobs may be
allocated through social networks (Korpi, 2001). The theoretical literature on the role
and implications of social contacts in the job search process has, in contrast, only
recently taken off on a wider scale and now examines a wide range of issues such as
wage structure, mismatch etc. (Montgomery, 1991; Mortensen and Vishwanath, 1994;
Calvo-Armengol and Zenou, 2005; Bentolila et al., 2004).
In this article we present a simple stylised overlapping generations model in which
labour-market institutions in particular, the mode of dissemination of information
about scarce job opportunities constitute a driving force creating endogenous stra-
tification and income correlation across generations. In the model, young individuals
decide whether or not to acquire skills; however, due to imperfections in the labour
market, skilled jobs are effectively being rationed. Information about job opportunities
is spread by word-of-mouth communication, implying that an individual is more likely
to hear about an opening in a skilled job if he has many skilled workers in his local
environment. This generates a lower expected return to skill-acquisition for individuals
from adverse social environments, making them less likely to invest in education. Based
on the income obtained during working life, an individual then chooses a residential
area, which defines the social environment of the individuals offspring. Using this
setup we find that, while there always exists an equilibrium in which stratification does
not occur, there may also exist stable equilibria with asymmetric or stratified
communities.
The model allows us to consider the effects of various factors on the stability of non-
stratified equilibria as well as on the existence of stratified equilibria and on behaviour
starting from such equilibria. We find for example that factors that generally encourage
participation in education (e.g. a higher wage return to education and/or lower costs
of education) can be inherently destabilising, making stratified equilibria more likely to
result. Similarly, if the economy starts from a stratified equilibrium, the externality
generated by the information transmission mechanism can generate perverse equilib-
rium effects: in particular, the model highlights how enhanced fundamental incentives
for human capital investment can lead to highly asymmetric responses and to more
equilibrium inequality in education.
The models in the literature that are closest to our are Benabou (1993, 1996) and
Durlauf (1996). Benabou (1993) focuses on the simultaneous choice of education and
6
Further evidence from the US are provided by Corcoran et al. (1980), Granovetter (1995) and Holzer
(1988), and for the UK by Boheim and Taylor (2001).
7
Indeed, the research to date seems to have generated a widespread pessimism concerning the efficacy of
US public employment services (Holzer, 1988) while the British findings give a more favourable picture of the
public employment service (Gregg and Wadsworth, 1996).

2007 ] STRATIFICATION, SOCIAL NETWORKS AND MOBILITY 785
residential choice, with local spillovers in education making those acquiring skills
willing to pay to reside together. In contrast, in our framework youngsters choose
education taking their locations (determined by the locational choices made by their
parents) as given. In this respect our approach is more similar to Benabou (1996) who
considers an model where parents, who differ in some characteristic, choose commu-
nities, and where a childs educational achievement depends on the parents charac-
teristic, on quality of the locally financed education, and on the composition of the
community. Benabou examines various possible types of generic complementarities
and shows how complementarities can amplify initial differences and make inequality
more persistent across generations. Durlauf (1996) considers a model with endogenous
sorting into communities where a childs educational achievement depends on locally
financed education, the social environment, and on luck. Durlaufs main focus is on
how endogenous segregation can generate persistent poverty. Our article differs from
the above mentioned papers in a couple of ways. First, while the above-mentioned
papers assume perfect labour markets, in our analysis labour market imperfections and
labour markets institutions are the key driving forces generating spillover effects.
Second, while in Benabou (1996) and Durlauf (1996) a key feedback mechanism from
local social environment to individual choices is provided by local education finance
(determined by some political mechanism), this is not the case in our model.
The article is organised as follows. Section 1 describes the model. Section 2 char-
acterises steady-state equilibria. Section 3 looks at the sustainability of non-stratified
equilibrium. Section 4 takes a closer look at stratified equilibria in terms of their
comparative statics properties. Section 5 discusses the efficiency properties of the
models equilibria while Section 6 looks at intergenerational social mobility. Finally,
Section 7 concludes.
1. The Model
We start by outlining the basics of the model. Time is continuous and the horizon is
infinite. Each individual belongs to a family characterised by overlapping generations.
Formally, an individuals lifetime has three economic phases: a youth-phase of length
T/2 during which education may be acquired, a working-life phase of length T, and a
retirement phase of length T/2. For simplicity we make the overlap short: each indi-
vidual parents a single child only at the very end of her working life.8 This implies that,
half the time the family has only one family member while the other half of the time it
has two. Each family occupies one house at any point in time.
The timing of economic activities over an individuals lifecycle is as follows:
A young individual must decide whether or not to acquire skills. Acquiring
education is, however, costly. Moreover, the individuals vary in aptitude or
talent, making the cost vary in the population. We take the cost to be entirely
financial (representing costs such as tuition fees that vary with ability thanks to
education providers being able to price discriminate by means of e.g. scholar-
ships and grants) but we also assume that there is a perfectly functioning credit
8
The short overlap ensures consistency of our assumptions that an individual makes a locational choice
based on her realised adult earnings and that the choice is without knowning the childs cognitive aptitude.

market on which the individuals can borrow. Hence there are no credit con-
straints. Let h be an individuals idiosyncratic cost of education. We assume that
h is independent across individuals in the population, drawn from a distribution
with support h; h. Let G(h) and g(h) be the CDF and PDF of h respectively; g(h)
is assumed to be positive on the entire support and the distribution is assumed
not to have any atoms.
During her working life an individual works and saves her earnings. There are
two types of jobs in the economy: good jobs and bad jobs. While good jobs can
only be filled by skilled workers, bad jobs can be filled by any worker. Bad jobs
are immediately available to anyone who wants them; good jobs, on the other
hand, are hard to find (see below).
When exiting the labour market the individual makes a decision about location
and consumption. Indeed, consumption only occurs in retirement. Individuals
who acquire education, thus, find themselves in the social environment chosen
by their parents; while it is important that education is acquired locally prior to
any possibility to move conditional on the childs ability, the assumption that
individuals cannot move during their working lives is for tractability.9
Our focus will be on steady states, and in order to ensure stationarity of the
endogenous variables in continuous time we assume that a frequent succession of
cohorts of individuals are born into the economy, each cohort being a continuum of
unit size. Formally, a new cohort is born every T/(2N ) units of time where N is a
(large) natural number. There are then, at any point in time, 4N individuals alive in the
economy. The number of families (which is the same as the number of houses), in
contrast, is 8N/3.10 We can then let the frequency of cohorts grow by letting N ! 1.
There is a single numeraire consumption good in the economy, produced by the
working individuals.
There are two exogenously given intrinsically identical locations of equal size; in
steady state each cohort will be equally split between the two locations. While the two
locations are intrinsically identical they can, in equilibrium, differ in terms of skill-
composition, referred to below as the local social environment. Since a parents
location choice occurs when her offspring is entering the youth period this choice
determines the social environment that the offspring will have during her youth and
working-life. Parents are assumed to be altruistic towards the children and may
therefore be willing to pay for a house in an area with a more favourable social
environment. We assume however that parents make their location choices before they
learn their offsprings cost of education.
Since the focus of the study is on social environments as a channel for shaping the
transmission of economic success across generations we adopt the modelling strategy of
making this the only channel. In particular ability is not transmitted across generations
9
It seems clear that our qualitative results would stand as long as an individuals initial social environment
has an effect on their work-life prospects.
10
The number of individuals alive at any given point in time is the length of an individuals life, which is
2T, divided by the time elapsed between the birth of successive cohorts, which is T/(2N ). The number of
families is smaller due to the fact that half of all family have, at any point in time, two current members.

(reflected in the assumption that h is i.i.d.), nor are there any other transfers or
investments.
Workers meet in a common labour market; this creates scope for global (or inter-
community) spillovers. Global spillovers occur through the process by which
information about job-openings is disseminated. A fraction of the attractive good jobs
are allocated through connections. A skilled job-seeker may hear about a job-opening
from another skilled neighbour (as described below), making the individuals
expected returns to education depend in part on the local social environment.
Next we describe various components of the model in greater detail, starting with a
description of the labour market.
1.1. Job Creation and Job-finding Rates

In this Section we detail the assumptions regarding wages and job-creation. The
assumptions made in this Section can be derived from an efficiency-wage model. This
underlying model is presented in Appendix B.
A workers productivity in a good job (for which skills are necessary) is constant equal
to wH while her productivity in a bad job is wL (irrespective of her skills); wH > wL. Bad
jobs are always available to any worker who wants one; firms offering these jobs act
competitively and pay the competitive wage wL. Good jobs pay the higher wage wH but
they are not immediately available.
If one more worker in a given cohort acquires skills, there will be one more good job
created over the working life of that cohort. However, the date of its creation, and
hence the age at which it becomes available, is a random variable with CDF F(). The
support of F is [0, T], and it has an associated density which is strictly positive on the
entire support.11 The key aspect of F(t) is that it is independent of the number of
workers acquiring skills and their geographical distribution. Let t0 be the expected
value associated with the distribution F(). There is on-the-job search in the sense that
a skilled worker can work in a bad job while waiting for a good job. Once a skilled
worker finds a good job there are no natural separations so she can continue to work in
that job until retirement.
The working of the labour market is in line with the tenet of search models. Each
worker searches for a job until an appropriate match is found, and the frictions
underlying the potential for mismatch are not modelled structurally; the absence of any
asymmetric information attests to this fact. The underlying frictions may, for example,
be due to the employer facing a screening cost in order to assess a workers skills. This
would, obviously, make it unattractive for the employer to search for skilled workers at
random; moreover, the two mechanisms devised below informal recommendation
through social networks and formalised posting can both naturally be interpreted as
means of dealing with precisely this problem.
1.2. Social Environments and Word-of-mouth Communication

Each community is characterised by a social environment, defined in terms of the
skills of the workers living in that community. In particular, let cj, j 1, 2, denote the
11
It is implicitly assumed that there is a separate job market for each cohort.

fraction of workers (i.e. individuals of working age) in location j who are skilled.12 Since
we have assumed that there is a frequent succession of cohorts and since we are
focusing on steady states we treat c1 and c2 as constant over time, both over an indi-
viduals lifetime and across generations.
We assume that information about (a fraction of) the good jobs created is spread
through word-of-mouth communication among skilled workers. Some simplifying
assumptions allow us to determine the implications of the social environment:
Suppose that all families have the same number of immediate neighbours and
that those neighbours are representative of the area.13
Information about good jobs can only be passed on between immediate
neighbours.
There is no relay of information: information can only be passed on once.
Each skilled worker in the economy (whether currently in a good job or not) is
equally likely to hear about any good job that is created.
It is worth stressing at this point that the model also allows for some or all bad jobs to
be allocated through social networks; since there is no waiting time for a bad job, this
has no further consequence for the analysis.
Returning to the idea of a screening cost underlying the job-finding mechanism, it
seems quite reasonable that information reaches skilled workers only through their
school networks, say and that it is possible for the original receiver of the information
to credibly recommend another skilled worker. Montgomery (1991) develops an
adverse-selection model of referrals focusing directly on the hiring decision of firms,
thereby providing a foundation for the importance of social networks quite distinct
from ours. He also synthesises some empirical evidence on the importance of referrals
and a salient observation in that context is that referred workers earn higher wages (in
particular in the short run) and have lower quit rates; this arguably corroborates the
notion that referrals are associated with better matches.
Under the above assumptions the relative local job-finding rates (for skilled jobs)
reflect the relative frequencies of skilled workers in the two areas, c1 and c2.14 Specif-
ically, let aj(t) be the job-finding hazard of a skilled worker of age t in area j. We then
have that the local hazards stand in constant proportion to each other: for all t 0,
a1 t c1
: 1
a2 t c2
The skill frequency cj among the local working adults is thus indeed an appropriate
definition of the local social environment; moreover, what matters for the job-alloca-
tion process is the relative social environments c1/c2.
12
As noted below, this will not generally be the same as the skill composition of the retirees living in the
area. Retirees on the other hand do not transmit information about job openings.
13
Our model of informal dissemination of information about job openings can be viewed as a highly
simplified version of the model in Calvo-Armengol and Zenou (2005).
14
Formally, this rests on the assumption that skilled jobs that are created are cohort-specific and that there
is a frequent succession of cohorts. This implies that the probability that a skilled worker who is first to hear
about a specific vacancy will need it for herself is negligible.

In order to be able to explore the role of labour-market institutions we will however
assume that some good jobs are formally advertised. Formal posting may work as a
screening device if the posting institution has some screening ability. This is the very
idea behind e.g. the Swedish Employment Service which in spite of its flaws quite
clearly is helpful in the matching process.15 While the chance of a worker getting an
informally advertised job depends on her (relative) social environment as described
above, all skilled job-seekers have an equal chance of getting a formally advertised job.
To capture this we include a parameter v 2 [0, 1] to measure how many good jobs are
allocated informally and generalise (1) to
a1 t c
u 1 t t 1 : 2
a2 t c2
The special case v 1 is the case where all good jobs are informally allocated, while
v 0 is the case where all good jobs are formally allocated. The parameterisation of the
mix between formal and informal job allocation in (2) reflects the view that this mix
can be influenced by policy; the government may for instance vary the efforts exerted
on formally posting as many jobs as possible in a way that is captured by variation of v.
The specification represents a shortcut; a deeper understanding of the mix between
formal and informal job allocation could be gained by explicitly modelling underlying
distortions combined with heterogeneity among employers. The resulting trade-off
between the two means of posting would not, as far as we can see, interact with edu-
cation choices and mobility in an interesting way, however; in light of our focus on
these factors, the current parameterisation seems appropriate.
When the two areas differ in terms of their social environments they will hence also
offer different rates of entry into good jobs. As a result there will, in steady-state
equilibrium, be two local job-finding CDFs, denoted F1(t) and F2(t) respectively,
relating time in the labour market t to the probability of having found a good job.
There are two key relations involving the local CDFs:
From the relation between the local hazard rates (2) it follows that, for all
t 2 [0, T]:16
1 F1 t 1 F2 tu : 3
Also, F1(t) and F2(t) must satisfy the following adding-up condition
X cj X cj
Fj t F t ; 4
j1;2
2 j1;2
2
since both sides of (4) measure the total number of skilled workers who have found
good jobs after t units of time.
15
Calmfors et al. (2002) cite evidence on the effectiveness of the efforts of the Swedish Employment
Service concluding, in particular, that intensifying the efforts in a way that is targeted at some clients is
effective in the sense that the future labour-market prosects of those clients are improved relative to the
control groups; while there may be some crowding out involved, the notion that employment services are
effective is corroborated.
16
To see this relation
Rt recall that aj Fj0 t=1 Fj t is the hazard rate associated with Fj(); hence,
ln1 Fj t 0 aj sds. Using (2) the result is then immediate.

It is easy to verify that (3) together with (4) imply a unique solution (F1(t), F2(t))
(both in the unit interval) for any value of c1,c2 and F(t) 2 [0, 1]. Equations (2) to (4)
also immediately imply the following stochastic-dominance result:
cj > ck implies Fj t > F t > Fk t for all t 2 0; T : 5
We can also define

Z T
tj cj ; ck 1 Fj tdt; 6
0
as the expected waiting time for a skilled worker in area j, i.e. the average time that the
skilled worker must spend in a bad job before finding a good job.17 As a corollary of the
stochastic-dominance result (5) we then have that:
cj > ck implies tj cj ; ck < t0 < tk ck ; cj ; 7
where we recall that t0 is the expected waiting time associated with the distribution F().
1.3. Local Complementarities in Human Capital Investments and Educational Choices

While the main focus of our analysis will be on the global spillovers that obtain since
workers from different neighbourhoods meet in a common labour market we will also
allow for local spillovers in the form of complementarities in education; as will be
demonstrated below, there are important interactions between the two. Education is
assumed to be carried out at the local level, i.e. within the two neighbourhoods, and the
education cost of a single individual is allowed to depend on the fraction of her peers
that acquire skills.18 It is assumed that the relevant peers are those of the individuals
own cohort.19 The local complementarity in education is represented by a function
p(c) that rescales the individuals education cost. The effective cost of education to an
individual from area j, with idiosyncratic cost h, is hp(cj), where cj is the fraction of
individuals in that area who acquire skills. p(c) is assumed to satisfy p(0) 1, p0 (c) < 0
(and finite) and p(1) > 0.
For future purposes it is useful to define the elasticity of the local complementarity,
p0 cj cj
epj cj 0: 8
pcj
This elasticity is zero at cj 0 and thus increasing over some range by construction.
Moreover, it is readily seen that the elasticity is everywhere increasing unless p() is too
convex (a sufficient condition being that (p00 p) (p0 )2).20 In economic terms, this is
17
RT
If Fj(t) is differentiable then tj cj ; ck 0 tfj tdt where fj t Fj0 t is the local density of job finding
times.
18
This follows a sizable body of literature on neighbourhood effects and peer-group effects; contributions
in economics that relate to this article include de Bartolome (1990), focusing on externalities in education,
and Benabou (1996) employing more general neighbourhood effects.
19
The complementarities could have a richer timing structure but this simple structure is in line with our
emphasis on global spillovers, and obviously in the interest of tractability.
20
The exact condition, dep/dc [1 c(|p0 |/p p00 /|p0 |)]/|p/p0 | 0, is significantly weaker.

true if the marginal benefit of additional individuals investing in education is not
falling too quickly somewhere.
Consider then the educational choice of a worker in area j with idiosyncratic cost h
(and hence effective cost hp(cj)). If she remains unskilled her lifetime earnings will be
TwL ; if, on the other hand, she invests in education, her expected lifetime earnings will
be TwH Dw tj cj ; ck , where Dw wH wL. Hence, she will make the investment if
and only if
Dw
h < hj T tj cj ; ck ; 9
pcj
where hj can be interpreted as the maximum idiosyncratic cost borne by someone in

area j who acquires skills. Prior to realisation of a workers idiosyncratic education cost
h, her expected lifetime earnings net of any educational cost incurred, denoted zj, is
community-specific:
Z h
zj maxTwL ; TwH Dw tj cj ; ck hpcj g hdh; j 1; 2: 10
h
Using that p() is non-increasing, along with (7), (9) and (10), immediately yields:
cj > ck implies hj > hk and zj > zk : 11
1.4. Locational Choices and House Prices

Upon exiting working life an individual makes a decision on how to allocate her
accumulated wealth over consumption and location. Specifically, the individual will
have inherited a house from her parent and may at this stage decide to sell this house
and buy one in the opposite area. The accumulated wealth of an individual comprises
of the earnings that she has accumulated, less the education costs that she may have
incurred, plus the value of the house that she has inherited. Let this total accumulated
wealth be denoted by y.
Since the areas are intrinsically identical, the only reason why a parent would be
willing to pay more for a house in a better area is because it improves on the
economic prospects of her child. Parents are assumed to be altruistic toward their
children and derive utility from their own consumption plus the welfare of their
offspring.
The own utility obtained by an individual is simply the utility obtained from the
consumption that she enjoys in retirement. Her consumption is her end-of-life wealth y
minus the value of the house that she chooses to occupy and the utility of this
consumption is assumed to be given by
y pj 1g
; 12
1g
where pj is the price of a house in area j, and where g measures the individuals
(relative) risk aversion. Let a 2 (0, 1) be the weight placed by an individual on the
expected welfare of her child. The overall utility obtained by a parent with end-of-life
wealth y, denoted V(y), then satisfies the following Bellman equation
( )
y pj 1g
V y max aEh V ~
z pj jj ; 13
j1;2 1g
where z~ is the random earnings (net of education costs) of the child, and where the
expectation is taken conditional on the child growing up in area j. Note that the parent
takes into account that the value of the house will be passed on to the child. Decreasing
marginal utility ensures that there is equilibrium sorting: if the areas differ in
attractiveness, then for any g > 0 the parents with above median end-of-working-life
wealth y will outbid the poorer parents for the houses in the better area.21 While any g > 0
ensures sorting, we choose to focus on the limiting case where risk aversion is vanishingly
small, g ! 0, since this greatly simplifies the analysis of prices and welfare.22
From (13) we see that, in the limiting case of risk neutrality, the indirect utility V() is
linear, V (y) y C for some C not depending on y. Using this to replace V() in (13)
we obtain
y C max y pj azj pj C; 14
j1;2
where zj is the expected earnings (net-of-education-cost) defined in (10). This equation

shows that, in the limit, all parents have the same preferences over locations. Hence it
must be that the two locations offer the same utility to the parents; specifically
pj a(zj pj) must be constant across the two areas. Solving for pj we obtain that
a
pj zj C: 15
1 a
Note in particular that that any price difference will be proportional to the (net-
of-education-costs) earnings differences.
At this point it is clear, as noted above, that the skill distribution of retirees will not
coincide with that of the working population. Taking as a leading example, the case
where at least half the population acquire skills (and all low-skilled workers fall below
the median in the end-of-life-wealth distribution), then if the areas differ in equilib-
rium all retirees in the better area will be skilled.23
In order to develop a welfare measure we can consider the ex ante welfare of a given
cohort (which, since the individuals are altruistic, also contains the discounted welfare
21
To see this suppose that area 1 confers better prospects than area 2, EV1 > EV2 where
EVj Eh V ~
z pj jj (and hence p1 > p2). A parent with end-of-life wealth y chooses area 1 if and only if
y p1 1g y p2 1g
1g 1g aEV1 EV2 > 0. Then note that the left hand side increases in y whenever g > 0.
22
The risk-neutrality assumption which has already been used when we characterised the individuals
education choices is an important ingredient in the efficiency-wage model presented in Appendix B. While
risk neutrality is clearly simplifying the efficiency-wage model in particular would be intractable indeed with
non-linear preferences it is also clear that it is not a driving assumption behind our main results.
23
The poorest individual in a cohort will be the individual who grows up in the disadvantaged area (who
thus inherits a low-value house) and acquires skills but only finds a good job just before retiring. The low
skilled individuals will appear as two atoms in the wealth distribution (since their earnings are not random
and they only differ in the value of their inherited houses). Hence we take as our leading example the case
where all low skilled individuals are located below the median of the wealth distribution. All individuals above
the median i.e. the individuals who purchase the houses in the advantaged area are then skilled.

of all future cohorts). Consider the expected utility of an individual born into area
j (and who thus inherits a house in this area). This expected utility is simply
Eh V ~
z pj jj zj pj C: 16
Substituting for the value of the house using (15) the expected utility is simply
zj/(1 a). Moreover, since half of the cohort is born into each area, the total expected
welfare of the cohort is
1 X zj
W : 17
1 a j1;2 2
2. Steady-state Equilibrium
So far we have taken the fractions of skilled workers in the two areas as given and shown
how c1 and c2 determine local job-finding rates and rational education choices. We
have not required that c1 and c2 be consistent with those education choices, however.
When we impose this consistency requirements we obtain a characterisation of a steady-
state equilibrium.
2.1. Characterisation
A worker in community j will only invest in education if he is talented enough so that
h < hj , defined in (9). The fraction of agents in community j acquiring skills will then
be cj G(hj). Rationality and consistency can therefore succinctly be summarised in
the following two equilibrium conditions:
( )
Dw
cj G T tj cj ; ck ; j; k 1; 2; j 6 k: 18
pcj
In words, (18) says that the educational choices of the agents in each area should be
rational given the social environments in both communities that those educational
choices generate. Equation (18) implicitly defines cj as a function of ck 2 [0, 1] which
we can denote C(). We will refer to C() as the reaction function and to a particular value
of that function, cj C(ck), as a within-area equilibrium in area j (conditional on ck). A
steady-state equilibrium (c1, c2) is then simply two mutually consistent within-area equil-
ibria: a pair (c1, c2) satisfying c1 C(c2) and c2 C(c1).
Uniqueness of the within-area equilibrium follows from a within-area stability con-
dition. In order to develop this condition define
jk @T tj ck
et ; j; k 1; 2: 19
@ck T tj
jj
et is the elasticity of expected time in a good job for a skilled worker in area j with
jk
respect to the skill rate cj in the own area; when k 6 j, et is the elasticity of expected time
in a good job for a skilled worker in area j with respect to the skill rate ck in the opposite

area. The within-area stability condition guaranteeing unique within-area equilibria is

then that
hj j jj
1 g hj e et > 0; 20
cj p
for all cj 2 [0, 1] which we take to hold throughout.24

It is worth noting that this is the point where the assumption that the social envir-
onment is the only channel for transmission of economic success manifests itself. The
equilibrium conditions developed above determine the equilibrium skill levels the cs
without reference to the preferences or the skill composition of the parental gen-
eration; in fact, the equilibrium conditions are independent of the process by which
parents are allocated to locations. This neutrality property is, arguably, useful for
studying in isolation the significance of the local social environment. As will be clear
below, however, the analysis and the interpretation of intergenerational mobility will
hinge on the altruistic link between generations.
2.2. Types of Equilibria

There may exist two types of steady-state equilibria: symmetric (or non-stratified) and
asymmetric (or stratified). While asymmetric equilibria may or may not exist, there
always exists exactly one symmetric equilibrium, henceforth denoted by *. In the
symmetric equilibrium a fraction c of individuals in both areas acquire skills. A simple
characterisation of the symmetric equilibrium is that c should be a within-area equi-
librium in response to itself c , i.e. c C(c ). Since C() is a continuous function
mapping the unit interval into itself it has a fixed-point; hence existence of c is
guaranteed. Uniqueness follows from the fact that C0 (c ) < 0 (which is shown below).
The symmetric equilibrium may or may not be stable in a sense to be made precise
below. A case with one symmetric equilibrium and two symmetric equilibria are shown
in Figure 1.
In the symmetric equilibrium the two communities offer exactly the same social
environment and hence the same opportunities for the children; no parent is therefore
willing to pay more to live in one area than in the other so the house prices in the two
areas coincide, p1 p2 p . Non-stratified communities are not the only possibility,
however. Intuitively, there can be stable outcomes where one community offers a more
favourable social environment and, as a consequence, young people are more prone to
invest in education there, thus perpetuating the difference in the social environments.
The scope for stratification stems from the fact that the workers from the two com-
munities meet in a common labour market; global spillover effects arise since the local
social environments in both communities affect the prospects of young workers in each
of the two communities.25
24
The condition guarantees that the derivative of the right-hand side of (18) does not exceed one, which
corresponds to a local expansion of education not being self-reinforcing, in the abscence of adjustment in the
other community. The condition involves local and global spillover effects, and rules out the local comple-
mentarity being too strong.
25
Multiplicity stemming from local spillovers have been ruled out by the stability condition (20) which
guarantees uniqueness of the within-area equilibrium.

1
1 = (2)
2 = (1)
0
0 1
1
Fig. 1. An Example with One Symmetric and Two Asymmetric Equilibria
The number of steady-state equilibria will always be odd: if (c1, c2) is an asymmetric
equilibrium, its mirror image is also an equilibrium. Hence, we can without loss of
generality focus on the case where c1 c2. Even though there can, in principle, be any
odd number of equilibria we focus on the more plausible cases where
(i) the symmetric equilibrium is the only equilibrium, or
(ii) there is, in addition to the symmetric equilibrium, a single asymmetric equi-
librium, c1 > c2.26
2.3. Stability
Our notion of stability is the standard one based on the reaction function C(), viz. the
one requiring that a myopic adjustment process with the cs being adjusted alternately
converge to the equilibrium. As is well known, an equilibrium (c1, c2) is stable
0 0
according to this definition if and only if the slopes satisfy: |C (c1)||C (c2)| 1. An
expression for the slope of the reaction function can be developed from its definition
(18). Differentiating through this equation with respect to ck and making use of the
elasticity definitions (8) and (19) we obtain that
jk
g hj hj =ck et
C0 ck j jj
: 21
1 g hj hj =cj ep et
We show below (Lemma 2) that the slope is negative at any symmetric equilibrium. The
symmetric equilibrium is hence stable if and only if C0 (c ) 1 and unstable if
C0 (c ) < 1.
26
As noted above, the mirror image is also an equilibrium; we count qualitatively distinct equilibria only
however.

Given our assumption that there is either a single symmetric equilibrium or one
symmetric and one asymmetric equilibrium the following observation can easily be
verified: if the symmetric equilibrium is the unique equilibrium, it is also stable. If, in
addition to the symmetric equilibrium, there is an asymmetric equilibrium, then the
latter is stable while the symmetric equilibrium is unstable.
2.4. The Nature of the Global Spillover

To gain further insight into the global spillover, consider how the local expected
waiting times t1 and t2 defined in (6) are related to c1 and c2. Note first that if there
were no global externalities, e.g. if all good jobs were allocated through formal chan-
nels, v 0, then both local waiting times would be equal to t0 , i.e. the waiting time
associated with the basic job creation process. When at least some jobs are allocated
through social networks, global spillovers obtain and the level of education in any one
area, cj , will affect the expected waiting time in both areas.
The effect of an increase in cj can be broken down in two parts a competition
effect and an adding-up effect. The competition effect captures how an increase in
cj affects the local waiting times by affecting the relative social networks (as measured by
u) and hence the relative local waiting times. The competition effect will hence have
opposite signs in the two areas: an increase in cj improves the set of connections that a
skilled young worker in area j can use to find a good job; this effect comes at
the expense of the workers in the other area and hence reduces tj and increases tk . The
adding-up effect, in contrast, intuitively captures the impact of an increase in cj on the
two local waiting times given their relative size.27 Hence the adding-up effect must have
the same sign in both areas. The adding-up effect obtains since the average waiting time
across all workers must always be given by t0 : by integrating (4) it is easy to see that the
following holds:
c1 t1 t0 c2 t2 t0 0: 22
The sign of the adding-up effect will depend on whether education is expanded in
the advantaged or the disadvantaged area; suppose that education is expanding in the
relatively disadvantaged area i.e. initially cj < ck, implying that tj > tk . The firms will
respond by creating equally many new jobs that have an average waiting time of t0 < tj .
Since (22) must still hold, t1 and t2 must both decrease: intuitively, since the newly
created jobs have shorter waiting times than the newly skilled workers, all workers will
now be able to find jobs, on average, faster.
The upshot is that the effect of expanding human-capital investments in either
community on the disadvantaged area is always unambiguous. This is formally noted in
the following Lemma:
Lemma 1 If cj ck, then @tj =@cj < 0 and @tj =@ck > 0, while if cj > ck both effects are
ambiguous.
27
We should stress that the argument is presented here in intuitive terms. In reality, u does not fix the
relative value of the local waiting times but rather the relative size of the log of the survival function, i.e.
ln [1 Fj(t)], for all values of t (as can be seen from (3)). However, since the waiting time is an integral of the
survival function, the result goes through.

Consider then how the global spillover is reflected in the reaction function. Note
that, trivially, if there were no global spillovers, then the reaction function would be
jk
flat. (To see this, simply note from (21) that et 0 implies that C0 () 0.) Hence the
non-trivial shape of the reaction function obtains from the global spillover. We can
then make a couple of observations with respect to the shape of the reaction function.
First, note that ck > c implies that cj C(ck) < c . This follows from (7) and (18)
along with the stability condition (20). Hence, if there is an asymmetric equilibrium
there will be one area that is advantaged and one that is disadvantaged relative not only
to each other but also relative to the symmetric equilibrium.
Second, note that C(0) c . This is intuitive: if no one acquires skills in area k, then
the existence of that area is irrelevant for those acquiring skills in area j: the expected
waiting time in area j will then necessarily be t0 , i.e. the waiting time associated with the
basic job creation process, which is the same waiting time they will have in the sym-
metric equilibrium.
Thirdly, the reaction function is downward-sloping at the symmetric equilibrium,
C0 (c ) < 0. (This is formally demonstrated in Lemma 2 below.) Indeed, using Lemma 1
this can be shown to extend so that ck c implies that C0 (ck) < 0. The intuition is
exactly that an expansion of education in the advantaged area has an unambiguous
negative effect on the incentives for skill acquisition in the disadvantaged area.
3. Sustainability of a Non-stratified Equilibrium

What factors contribute to making non-stratified equilibria more likely to be sustain-
able? Can we expect factors that promote human-capital acquisition also to promote
social integration? A partial answer to these questions can be obtained by considering
in detail the stability of the symmetric equilibrium. We will show that, perhaps some-
what surprisingly, factors that generally encourage investments in human capital can
naturally be inherently destabilising, thus contributing to making social stratification
more likely.
In order to explore the stability of the symmetric equilibrium it is useful to explore
the slope of the reaction function (21) in some more detail by evaluating it at a
symmetric equilibrium. In order to simplify the analysis we make the following
assumption about the distribution of education costs:
Assumption 1 The idiosyncratic education cost h has a uniform distribution on the support
0;
h and hence gh g 1=
h and G (h) gh.
We can then show the following result:

Lemma 2 The slope of the reaction function at the symmetric equilibrium satisfies
tK
C0 c 0; 23
1 ep tK
Z T
1
where K 1 F t ln1 F tdt > 0.
2T t0 0
The Lemma highlights how the slope of the reaction function at a symmetric equi-
librium depends only on three factors. First, it depends on the fraction v of good jobs
that are allocated through word-of-mouth communication. Second, it depends on the

severity of the labour market distortion as measured by the CDF F () which enter in the
form of the statistic K. Finally, it depends on the local spillovers through the elasticity
of the local complementarity ep .
The statistic K is strictly positive if and only if there are delays in the job-creation
process: F (t) ! 1 for all t implies that t0 ! 0 and K ! 0. The upshot of this is that
C0 (c ) goes to zero if either
(i) all jobs are allocated through formal channels, v 0, or
(ii) there are no labour-market distortions, K 0.
This complementarity of v and K in (23) highlights that the mode of job-allocation is
only relevant if there are labour-market distortions and, conversely, the fact that there
are labour-market distortions only generate global spillovers if at least some jobs are
allocated through social networks.
One would generally expect the statistic K to be positively related to the expected
waiting time, t0 . This turns out to be true in most reasonable cases, but not
completely generally. Consider a deterioration in the job-creation process that uni-
formly shifts the CDF F () (except at the endpoints). We can then show that such a
worsening of the speed of job-creation increases the statistic K under fairly general
conditions.28
Lemma 3 A uniform reduction in the CDF F() increases the statistic K if either:
1. the density of t, oF(t)/ot, is decreasing on [ 0, T ], or
2. the CDF, F(t), reaches the level 1 1/e 0.63 for sufficiently small t.
The two sufficient conditions are closely related since they both rule out waiting-time
distributions where most skilled workers find jobs towards the end of their working
lives.
Consider as an example the following parameterisation (24) of F () (which is also
the one derived from the efficiency-wage model presented in Appendix B),

T t K
F t 1 , K > 0: 24
T
In this parameterisation the statistic K and the average waiting time t0 are both
inversely related to the parameter K and hence positively related to each other,
1 T
K and t0 : 25
21 K 1 K
Note that this is true for any K > 0 (including any K 2 (0, 1) at which neither of the
previously stated sufficient conditions is satisfied).
From the above, it is clear that if any other factor besides the labour-market distor-
tion and the job-creation process (as represented by K and v respectively) is to affect
the stability of the symmetric equilibrium, it will have to do so through the elasticity ep .
In Section 1.3 we argued that the most reasonable assumption is that ep is increasing
28
Note that the uniformity requirement is sufficient but not necessary.


in c . Any factor that increases the scale of the symmetric equilibrium will then also
make the reaction function more steeply sloped via ep . We will refer to this as a scale
effect. In order to perform comparative statics on the stability condition we assume
that the local complementarity implies exponentially decaying education costs.
Assumption 2 The local complementarity in education implies exponentially decaying edu-
cation costs, p(c) exp (bc) for some constant b > 0, and hence ep bc .
Note that we focus on the case where there are some strictly positive local com-
plementarities since we know that, in their absence, only v and K influence the stability
of the symmetric equilibrium.
We can now proceed to explore how various factors affect the stability of the sym-
metric equilibrium. Since the symmetric equilibrium is stable if and only if
C0 (c ) > 1 we will say that a factor destabilises (stabilises) the symmetric equilibrium if
it decreases (increases) C0 (c ), either directly or indirectly through c . The factors that
we will consider are:
(i) A reduction in education cost, represented by an increase of the (constant)
density g.
(ii) An increase in the skill wage premium, represented by an increase in Dw.
(iii) An increase in the fraction of jobs that are allocated through social networks,
represented by an increase in v.
The first change corresponds to the education cost of each individual being reduced
by the same proportional factor. Since the wage gap reflects the underlying technol-
ogies, an increase in Dw may be interpreted as a skill-biased technological change.
Hence the first two factors both tend to generally encourage educational investments.
We can summarise the unambiguous effects as follows.
Proposition 4 Given the existence of local complementarities in education, b > 0, all factors
(i)(iii) destabilise the symmetric equilibrium.
The Proposition has two parts. The property that (iii) destabilises the symmetric
equilibrium is an important but unsurprising fact that, moreover, can easily be shown
to hold under less restrictive assumptions.29 The property that the symmetric, equal
opportunity shocks (i) and (ii) destabilise the symmetric equilibrium, on the other
hand, is more noteworthy; as we note elsewhere, this shows that measures intended to
promote equal opportunities by promoting education may have the unintended effect
of facilitating stratification. The mechanism by which these shocks destabilise the non-
stratified equilibrium is permeated by the scale effect: whenever the elasticity of the
local complementarity increases with c (as it does under Assumption 2), any expansion
of education including a completely symmetric expansion at a symmetric equilibrium
reduces the marginal cost of a further expansion, and this marginal-cost reduction
undermines the stability of the symmetric equilibrium.
Remark 1 While it would be tempting to conclude from (23) that an increase in the labour-
market distortions as measured by the statistic K will be destabilising in the same way that v is, this
29
An increase in b is also easily shown to destabilise the symmetric equilibrium.

is not generally true. The key difference is that, while changes in v do not affect the scale of the
symmetric equilibrium, an increase in K generally reduces c and can hence be stabilising.
4. Effects on a Stratified Equilibrium

The analysis of the stability of the symmetric equilibrium provided us with some insight
into what factors avert social stratification. We now proceed to consider whether the
same factors that permit stratified equilibria also make such equilibria in some sense
more polarised. Our starting point is thus the existence of a stratified equilibrium with
c1 > c2 .
It is useful to derive a general expression for the equilibrium effect on cj of a generic
parameter f. Recall that (18) defines the reaction function cj C(ck). Moreover we
0
know that a marginal increase in c1 has a negative impact on c2, i.e. C (c1) < 0 (see
Figure 1); the effect of c2 on c1 is on the other hand ambiguous. The equilibrium
effects on participation in education in the two areas depend partly on the direct
effects on education incentives and partly on the social multiplier associated with the
global spillover. Define the direct effect (or partial effect) of f on cj, denoted ocj/of, as
the effect on cj that would have obtained had ck remained unchanged (obtained by
totally differentiating (18) while holding ck fixed). A positive direct effect, ocj/of > 0,
simply means that the reaction function C() shifts upwards locally. Then denote the
total effect on the steady-state equilibrium value of cj which includes global spillover
effects by dcj/df. It is then straightforward to show that

dcj 1 @cj 0 @ck
C ck ; j; k 1; 2; j 6 k; 26
df D @f @f
where D > 0 since the equilibrium is locally stable. It is worth noting that the
responsiveness across areas, measured by the slope of the reaction function, arises
fundamentally from the global spillover effect due to the workers meeting in a common
labour market, but is amplified by any local complementarities in education.
Consider first a change in the importance of social contacts in the job-finding pro-
cess as measured by the parameter v. Given that c1 > c2 an increase in v increases the
job-finding hazard in the advantaged area relative to that in the disadvantaged area,
thus causing t1 to decrease and t2 to increase. This implies that the direct effect ocj/ov is
negative for area 2 and positive for area 1. Since C0 (c1) < 0 the spillover effect affecting
area 2 is then also strictly negative and the equilibrium effect is to reduce c2 (while the
effect on area 1 is ambiguous).30
Proposition 5 An increase in the fraction of good jobs that are allocated through social
networks, v, unambiguously decreases education in the disadvantaged community.
As it turns out, however, this is the only unambiguous response from an asymmetric
equilibrium that can be derived. Importantly, any factor that has an unambiguous direct
30
The ambiguity for area 1 stems from the fact that t1 increases as a result of fewer individuals acquiring
education in the disadvantaged area 2.

effect that goes in the same direction in both communities will have ambiguous equilibrium effects
on the local skill rates due to the global spillover. This covers the two remaining key
parameters examined above: a reduction in education costs represented by an increase
in g, and an increase in the wage return to skill Dw.31 Hence we cannot rule out highly
asymmetric responses to factors that generally encourage education.
One possibility is that there will be a positive response in the disadvantaged group
but almost no response in the advantaged group. To see this, suppose e.g. that the
participation rate in the advantaged area is already very high, approaching full parti-
cipation. Then it is likely that the direct effect in this area will be quite small and the
reaction function locally quite flat, C0 (c2) 0. In this case the only effect is the direct
positive effect in the disadvantaged area since there are virtually no direct effect on the
advantaged area and no global spillover effects in either direction. Another strong
possibility, however, is a marked positive response only in the advantaged area and a
zero or even negative effect in the disadvantaged area. To see this, suppose that there is
a positive direct response in both areas and that the reaction function in the advant-
aged area is again locally quite flat, C0 (c2) 0. In this case the spillover effect from the
advantaged area will counteract, and may outweigh, the direct positive effect in the
disadvantaged area, while in the advantaged area the total effect is the positive direct
effect. In sum, we find that factors that generally encourage education have ambiguous
effects on participation in education, with a marked possibility that the educational
responses can be highly asymmetric across stratified communities.
It should be stressed that finding that factors that generate seemingly unambiguous
incentives for education can induce highly asymmetric responses is a potentially
important result in its own right. In a recent article, for example, Bedard (2001)
presents evidence that greater university access (as measured by the presence of uni-
versities in the local region) is associated not only with a higher rate of university
enrollment but also with a larger high school dropout rate, thus implying a more
polarised distribution of educational outcomes. Bedard shows that this is compatible
with a signalling model of education. However, it is easy to see that her finding is
equally compatible with the type of social-interactions model presented here (inter-
preting greater university access as corresponding to lower cost of education). Hence
we can conclude that there is empirical evidence that is consistent with the current
model (but not with a pure human capital model) and that the current model provides
an alternative to the signalling model for explanation for that evidence.
5. Efficiency
Is stratification bad for welfare? The interpretation of this question is not as straight-
forward as it may first seem since it is not obvious what is the relevant comparison. In
order to analyse the efficiency of the equilibria in the model it useful to start by
disentangling aggregate welfare W (defined in (17)) by separating production from
education costs.
31
This positive direct effect of these two parameters are shown in the proof of Proposition 5. Note also that
if the generic parameter f has a positive direct effect, then both total effects cannot be negative since this
would require that [C0 (c0 1)]1 < (oc1/of)/(oc2/of) < C0 (c2) which contradicts that the equilibrium is stable
(since this implies that C (c1)C0 (c2) 1).

Consider first education costs. Denote the cost of educating a fraction c of a local
communitys cohort (measured per capita) by
Z hc
Cc pchg hdh; 27
h
where h(c)G1(c). This cost is strictly convex if

Z hc
00 00 pc
C c p c hg hdh 2p0 hhc > 0: 28
h g hc
If there were no local complementarities in education (i.e. p(c) 1 for all c) then the
cost C(c) would be guaranteed to be strictly convex: the cost in this case increases more
than proportionally with the number of students since the marginal student will always
have higher idiosyncratic cost than the infra-marginal students. Local complementa-
rities, p0 (c) < 0, counteract this effect by reducing each individuals effective idiosyn-
cratic cost of education as the number of students increase. However, since our main
focus is not on local complementarities we assume that C(c) is strictly convex
throughout. Hence we assume that the first mechanism dominates.
Note that in this model an individuals location during the youth (and adult) phase is
determined by her parents locational choice, and, moreover, since cognitive abilities
are i.i.d. the distributions of the idiosyncratic education costs h are always identical in
the two areas. Convexity of C () then has straightforward implications for the efficient
allocation of education. In particular, it implies that symmetry is efficient: the cost of
educating a fraction c of the individuals of a given cohort is minimised by educating a
fraction c of the youth in each area.
Consider next aggregate output of a given cohort. Equation (22) shows that the
expected waiting time of a randomly chosen skilled worker in the economy is always t0 ,
i.e. the waiting time associated with the exogenously given job-creation process. It then
follows that the aggregate output of a cohort is linear in the aggregate skill rate
c c1 c2 =2; in particular, aggregate output is TwL DwT t0 c. Hence we can
rewrite our welfare measure (ignoring the constant 1/(1 a)) as
z1 z2 1X
W TwL Dw T t0 c Ccj : 29
2 2 j
We can now start to approach the question of whether stratification is bad for wel-
fare. A first observation is that a stratified outcome is never desirable in the sense that
any asymmetric allocation is welfare dominated by some symmetric allocation. This
follows trivially from convexity of the cost function C(): any asymmetric allocation is
immediately dominated by the symmetric allocation with the same aggregate level of
education.32 It is a rather weak result however since the dominating symmetric
allocation need not be an equilibrium (not even an unstable one).
32
This result actually continues to hold (with weak dominance) even if C() fails to be convex. To see this
note that additive separability of W in c1 and c2 implies that there is always a symmetric efficient allocation: if
bc 2 arg maxc DwT t0 c Cc then the symmetric allocation c1 c2 bc is an efficient allocation.

A more relevant comparison is between the asymmetric and the symmetric equi-
librium. Suppose that the economy is at an asymmetric equilibrium (c1, c2). Would
the economy then have been better off if it had been able to defy stability and
maintain the symmetric equilibrium c ? An affirmative answer to this question can be
given for the point where asymmetric equilibria emerge. In order to demonstrate this
result we will rely on the parameterisations given in Assumptions 1 and 2. We then
have that an increase in the density g and an increase in the parameter b both
represent decreases in effective education costs. We can then consider the following
three factors:
(i) A reduction in education cost, represented by an increase of the (constant)
density g
(ii) A (marginal) skill-biased technological improvement, dwH > 0, dwL 0 with
dwH > dwL
(iii) A strengthening of the local education spillovers, represented by an increase in b.
From Proposition 4 we know that all three factors destabilise the symmetric equi-
librium and can hence cause the emergence of a stratified equilibrium. The local result
concerns the effect of the aforementioned three changes starting from a situation
where the symmetric equilibrium is just stable:
Proposition 6 Let the symmetric equilibrium c be just stable and consider either marginal
change (i) (iii). The emergence of a stable stratified equilibrium then implies that the welfare
impact is less positive than it would have been along the symmetric equilibrium.
The result suggests that when there is a stratified equilibrium welfare would have
been higher in the (unstable) symmetric equilibrium. However, it should be noted
that Proposition 6 is only a local result. Why does it not extend to the global case?
The reason is that aggregate education may be higher in the asymmetric equilib-
rium than in the symmetric equilibrium. With positive local spillovers there is
generally too little education in any equilibrium; hence the asymmetric equilibrium
may welfare dominate the symmetric one only if it involves a higher aggregate skill
rate.
6. Mobility
Intergenerational mobility tends to be measured in two different ways in the lit-
erature. The perhaps most common approach is to look at the correlation in out-
comes between generations. A second approach is to use a transition-matrix
characterisation of mobility, e.g. between income deciles. In the current model
successive generations within a family are linked via the locational choices made by
the adults at the end of their working lives. Indeed, this is the only link
between generations since there is, by assumption, no transmission of human cap-
ital and no other transfers. In this Section we outline two measures of intergener-
ational mobility and explore the relation between asymmetric outcomes and
mobility.

Consider a given family. It is easy to see that the family history will be a Markov
process in which the locational choice at time t serves as a state variable. Note e.g. that
the exact earnings, wealth, or education of the parent are not correlated with the
childs outcomes once we condition on the area into which the child is born.33 There is
a large number of families in the economy each characterised by the same Markov
process and there is no correlation across families. Hence, assuming that there is
mobility between areas in equilibrium, the steady state cross-sectional distributions of
locations and wealths in the population will correspond to the limiting distributions
associated with the Markov process.
Intergenerational social mobility is frequently measured in the literature as the
intergenerational correlation in earnings (Solon, 1999). Here we focus instead on end-
of-working-life wealth y for two reasons. First, wealth directly corresponds to utility and
hence the correlation in wealth measures the correlation in well-being. Second, end-
of-working-life wealth is directly related to the geographical mobility since it determines
the locational choice. Hence let yt be the end-of-working-life wealth accumulated by the
adult in generation t of an infinitely lived family. We then define:
Definition 1. The intergenerational wealth correlation is q Corr(yt, yt1).
Following the literature we would say that there is perfect mobility if q 0. A

second natural measure of mobility is the probability of geographical move. Let l be
the probability that an individual who grows up in area 1 moves to area 2 or, vice versa,
from 2 to 1. Formally:
Definition 2. The intergenerational transition mobility, denoted l, is the probability that an
individual born into area j chooses, at the end of her working life, to move to the other area k.
Perfect mobility in this case is l 1/2 implying that a person growing up in area j is
equally likely to choose area j and k at the end of her life. If l 0 there is no transition
mobility.
The two measures of mobility are clearly related since the locational choices depend
on wealth but they not exactly the same: the correlation q takes into account the whole
wealth distribution while the transition mobility only considers the probability of
switching from above to below the median (or vice versa). In a symmetric equilibrium
there is perfect mobility according to either measure.34 But the converse is also true: if
an equilibrium is not symmetric mobility is not perfect. We prove this for the case of the
intergenerational wealth correlation.
Proposition 7. Let c1, c2 be a steady state equilibrium with c1 > c2. Then q > 0.
A curious feature of the model is that the exact degree of altruism a does not
play any role in determining the set of steady-state equilibria and hence does not
affect the aggregate distributions of neither education nor earnings. Altruism
does however impact on the degree of intergenerational social mobility in an
33
We could, on the other hand, equally well have used end-of-life wealth y as a state variable.
34
Strictly speaking, the transition mobility is not well-defined since the locations are de facto identical
making the locational choice indeterminate. Assuming that, given this indifference between areas, parents
flip a coin when choosing location, perfect transition mobility follows.

asymmetric equilibrium, typically negatively, by generating sorting by wealth into
locations and also, on the margin, via the level of house prices. Indeed, stronger
altruism will increase the difference in house prices and, since the value of the
house is inherited, children that are born into a favourable area in terms of social
composition will also be favoured by a larger relative inherited wealth. The negative
impact of altruism on mobility can easily be shown for the case of transition
mobility.
Proposition 8. Let c1, c2 be a steady state equilibrium with c1 > c2. Then the associated
transition mobility l is decreasing in the degree of altruism a.
7. Discussion
Empirical evidence suggests the increased return to education that has been observed,
not least in the UK and the US, has been associated with a strengthening of the link
between parental income and childrens educational attainments. Determining the
mechanisms underlying the positive education-parental income relationship is of great
importance in order to identify appropriate policies to promote human-capital
investments and equality of opportunities. For example, policies designed to alleviate
financial constraints such as education subsidies and income transfer policies may
have unintended consequences if the link between parental income and education
decision is, in fact, not due to credit constraints. This point has recently been stressed
by several authors; e.g. Cameron and Heckman (1998), after finding empirically that
long-run factors appear to be of primary importance, simulate the effects of a general
increase in family income on college attendance. Their conclusion is that, while
increasing resources available to parents is likely to increase enrolment, the students
that are attracted into college have considerably lower ability than those already opting
to attend. If parental income matters through less direct but longer-run channels such
as e.g. the choice of neighbourhood, then a very different policy approach may be
required in order to promote equality in education; in particular, it may be necessary to
try to conceive of policies that more directly seek to minimising the effects of socio-
economic stratification.
In this article we have developed a simple model of the link between parental income
and childrens educational investments where the link obtains directly through
neighbourhood effects. The model formalises one particular role played by social
environments, namely the role played by social networks in job-finding processes.
While the model is still a version of a parental investment model in the sense that rich
parents can invest in good neighbours in order to improve the lifetime opportunities
of their children, credit constraints do not play a role. The model provides one
example of how, with this type of causal link, intuitions about the effects of policy or
other shifts in the environment may be very different from those obtained in more
atomistic models based on credit constraints. This was highlighted for example in the
finding that a general reduction in the cost of education or an increase in the returns
to skill, could lead to highly asymmetric educational responses across socioeconomic
groups.
Appendix A: Proofs
Proof of Lemma 1. The adding up condition (4) and the relation between the local job-finding
CDFs (3) define F1(t) and F2(t). Differentiating through this equation system and using (2) we
obtain that
@F2 t F t F1 t 1 F2 tu tc1 =c2 ln1 F2 t
; A1
@c1 c2 c1 u1 F2 tu1
and
@F2 t F t F2 t 1 F2 tu tc1 =c2 2 ln1 F2 t

: A2
@c2 uc1 1 F2 tu1 c2
If c1 c2 then F1(t) F(t) whereby the cross-effect (A1) is strictly negative. If c1 < c2 the cross-
effect (A1) has ambiguous sign. If c1 c2 then F2(t) F(t) whereby the own-effect (A2) is
strictly positive. If c1 < c2 the own-effect (A2) has ambiguous sign. The result is then immediate
from (6).
Proof of Lemma 2. Evaluating (A1) and (A2) at symmetry and using cj c implies that Fj(t)
F(t) and u 1 we obtain that

@Fj t @Fj t t1 F t ln1 F t
: A3
@cj @ck c 2c
c
RT
From (6), T tj 0 Fj tdt; differentiating this identity and substituting using (A3) yields
Z T
@T tj @T tj t
1 F t ln1 F tdt > 0: A4
@cj @ck c 2c 0
c
Differentiating (18) that defines the reaction function C() we obtain

Dw @ tj
ghj
pcj @ck
C0 ck : A5
Dw p0 cj Dw @ tj
1 ghj T tj ghj
pcj pcj pcj @cj
Then use (18) to substitute for Dw/p(cj), evaluate at symmetry, and use Assumption 1 (which
implies that c gh ); this yields

@T tj c
@ck c T t0 tK
C0 ck
A6
@T tj c 1 ep tK;
1 ep
@cj T t0
c
where
Z T
1
K 1 F t ln1 F tdt > 0; A7
2T t0 0
and where we made use of (A4). Finally the denominator is positive by the within-area stability
condition (20).
Proof of Lemma 3. Consider an increase in waiting times, parameterised by n, such that

Fn oF(t;n)/on 0 for all t with some strict inequality. From (6) we obtain that

Z T
dt0
Fn tdt > 0: A8
dn 0
Differentiating K(defined in Lemma 2)with respect to n and using (A8) yields

Z T
dK 1 1
Fn t K fln1 F t 1g dt : A9
dn T t0 0 2
The integral is positive for a uniform shift of F that is for constant Fn(t) < 0(except at the
endpoints) if
Z T
fln1 F t 1gdt 0: A10
0
This is obviously satisfied if F(t) > 1 1/e 0.63 sufficiently early, verifying part (2). To see
part (1) make a change of variables x F(t) (note that this maps [0, T] to [0, 1] monotonically)
and thus dt/dx h(x) 1/f(t) > 0 pointwise:
Z T Z 1
fln1 F t 1gdt ln1 x 1hxdx: A11
0 0
R1
Since 0 ln1 x 1dx 0 the integral is negative if h(x) is increasing,that is if f(t) is
decreasing.
Proof of Proposition 4. Given Assumption 2 ep bc > 0, which we use to0 substitute for ep in
(23). Consider first the effect of scale c ; using the substitution it follows oC (c )/oc < 0; hence
an increase in c is destabilising given the existence of local spillovers. Of the three factors in the
proposition only v has a direct effect (i.e. not via the scale). Differentiating (23) yields the
following direct effect
@C0 c
K1 bcd ; A12
@t
with d 1/(1 bc vK)2 > 0. The direct effect is thus negative. Consider then the effects via
the scale c . Both g and Dw (but not v) impact on the scale c . To see this, note that the symmetric
equilibrium satisfies c pc gDwT t0 . Differentiating this identity gives
@c @c
DwT t0 d > 0; gT t0 d > 0; A13
@g @Dw
where d 1=pc 1 ep > 0 where the inequality follows from within-group stability (20)
jj
(using that gh /c 1 and et > 0 at the symmetric equilibrium).
Proof of Proposition 5. The direct effects of the various parameters in the model can be obtained
by differentiating (18) holding ck constant and making use of Assumption 1 and 2. This yields
@cj @cj @ tj
cj 2 pcj d > 0; gDw d ; A14
@b @t @t
@cj @cj
gT tj d > 0; DwT tj d > 0; A15
@Dw @g
j jj
with d 1=pcj 1 ep et > 0, where the inequality follows from within-group stability
(20). Note that since b, Dw and g have the unambiguous direct effects, their total equilibrium
effect on c1 and c2 will generally be ambiguous (see (26)): only v can have unambiguous effect.
The impact of v on the waiting time tj is via the hazard ratio u defined in (2). Given that c1 > c2
an increase in v increases u. Using the same technique as in the proof of Lemma 1 an increase in

u can easily be shown to increase F1(t) and reduce F2(t) for all t 2 (0, T). From (6) this implies
that @ t1 =@t < 0 while @ t1 =@t > 0. Hence oc1/ov > 0 while oc2/ov < 0. The result then follows
0
from (26) using that C (c1) < 0 (see Section 2).
Proof of Proposition 6. We prove the result for a marginal reduction in 0 education costs
represented by dg > 0. (The other two cases follow the same lines.) Initially C (c ) 1 since
the symmetric equilibrium is just stable. The increase in g increases c (see (A13)) and hence, via
ep , makes the symmetric equilibrium unstable. dg > 0 hence causes the emergence of a stable
asymmetric equilibrium.
We first show that the increase dg causes the same response in the aggregate education rate
along either equilibrium. The asymmetric equilibrium is characterised by c1 C(c2) and c2
C(c1). Differentiating this equation system and evaluating at c1 c2 c yields

dcj
C0 c dck cg c ; j; k 1; 2; j 6 k; A16
dg c dg c
0
where cg(c ) oc/og > 0 (obtained from (18)). Using C (c ) 1 (15) shows that the impact
on the aggregate education rate c is
!
dc 1 dc1 dc2 cg c
: A17
dg c 2 dg c dg c 2
The symmetric equilibrium in contrast is characterised by c C(c ); differentiating immedi-

ately shows that the impact on aggregate education is the same dc /d g cg (c )/2.
Consider now the impact on welfare; since aggregate production is linear in the aggregate
skill rate the impact of dg on output is the same along either equilibrium. It remains to
consider the impact on aggregate education cost. Total education costs in the asymmetric-
and the symmetric equilibrium are C Cc1 Cc2 =2 and C C(c ) respectively. From
above we have that dg causes dcj and dc such that dc dc1 dc2 =2 dc with dc1 6 dc2.
Taking a second order approximation the difference in the growth of aggregate education
cost is
" #
C 00 c dc1 2 dc2 2 2
dC dC dc > 0; A18
2 2
where the inequality follows from C() being strictly convex and from Jensens inequality (noting
that the square function is convex).
Proof of Proposition 7. The random wealth of an individual born into area j is y~j z~j pj where
z~j is her location-specific random earnings (net of education costs). Recall that zj E~ zj and
that c1 > c2 implies z1 > z2 and p1 > p2 (see (11) and (15)). Hence we have that c1 > c2 implies
that y1 > y2 where yj E~ yj . Also let ym and y be the median- and mean wealth in the population
respectively. Then, given that c1 > c2, due to sorting, we have the following locational choice
rule: the adult at t chooses to buy a house in area 1 if and only if yt ym. Consider then the
covariance between yt and yt1; Cov(yt, yt1) E yt yyt1 y where we used Eyt y for
all t. It is convenient to take the expectation conditional on the location chosen by the adult at t.
Suppose first that this location is area 1. By the locational rule this is equivalent to yt ym. Note
that under this condition yt1 is an independent draw from the random variable y~1 . Hence we
have that
Eyt yyt1 yjyt y m y1 yEyt yjyt ym : A19

By similar logic we obtain
Eyt yyt1 yjyt < ym y2 yEyt yjyt < ym : A20
Using then that
(i) Pr(yt ym) 1/2,
(ii) y y1 y2 =2 and
(iii) the law of iterated expectations
we obtain that
y1 y2
Covyt ; yt1 Eyt jyt ym Eyt jyt < ym > 0: A21
4
The correlation q is Cov(yt, yt1)/Var(yt) > 0 (since Var(yt) Var(yt1) > 0).
Proof of Proposition 8. The steady state (c1, c2) induces two local earnings distribution with
CDFs which we can denote Uj(z), j 1, 2. Since end-of-working-life wealth y is earnings plus the
value of the inherited house the local CDFs of wealth can be written as Pr(y < y0|j) Uj(y0 pj).
Since half the population is born into each area, the median wealth ym is characterised by
P m
j 1,2Uj(y pj) 1. There are then two area-specific critical earnings: an individual born into
area j will, at the end of her working life, buy a house in area 1 if and only if her earnings
exceed zjcr ym pj . House prices depend on altruism: from (15) we have pj(a) [a/(1 a)]zj
where z1 > z2 (see (11)). From the characterisation of the median we obtain
U01
ym0 a p10 a U02
ym0 a p10 a 0: A22
It follows thatp10 a m0
> y a > p20 a, whereby z1cr a is decreasing in a and z2cr a is increasing.
The result follows immediately.
Appendix B: A Microfoundation
In this Appendix we present a simple microfoundation for assumption that the creation of good
jobs is spread out over the working life of a cohort. The model, which is a simple efficiency wage
model and draws heavily on Saint-Paul (2002), implies the existence of an aggregate CDF
function F() for the age at which skilled workers find good jobs. In particular, it implies that the
number of good jobs created at any age t is proportional to the total number of skilled workers in
the cohort (and, in particular, does not depend on social composition). The model also implies
that F(t) 1 which says that all skilled workers will have found good jobs by the time they retire.
Consider the following version of an efficiency wage model. A worker who is in a good job can
try to access a stealing technology. She might be caught trying, but if she is successful she can
steal an amount h (at no risk) from the firm at every moment until retirement. We want to find
the job-creation rate at each age t 2 [0, T] that is compatible with a worker in a good job not
misbehaving; under the assumption of free entry by firms, this will be the equilibrium job-
creation rate (along with the competitive wage wH).
It is useful to derive value functions measuring expected discounted future earnings. Let V N(s)
denote the value of being employed in a good job not trying to steal with s T t time left in the
labour market. Trivially, for all s 2 [0, T],
wH
V N s 1 er s ; A23
r
where r is the interest rate. Let VT(s) denote the value of trying to access the stealing technology
with s time left in the labour market. VT() satisfies the asset equation
rV T s wH qV S s V T s pU s V T s V_ T s; A24

S
for all s 2 [0, T] where V (s) is the value of having access to the stealing technology, U(s) is the
value of being fired, q is the probability of accessing the stealing technology, and p is the
probability of being caught trying. V S(s) is similar to V N(s) (with wH h in place of wH) while
U(s) satisfies the asset equation
rU s wL asV N s U s U_ s; A25
where a(s) is the rate at which the worker finds another good job. The equilibrium job-creation
adjusts so as to keep the no-trying condition V N(s) VT(s) satisfied with equality for all s > 0.
In order for some job creation to take place we assume that qh/p < wH wL. Substituting for
V S() and VT() in (23) gives

q 1
U s wH h 1 er s : A26
p r
Equation (A25) can then be used to solve for the job-finding rate,
rK
as ; A27
1 er s
where

p q p Dw
K Dw h 1 > 0: A28
qh p q h
The constant K measures inversely the labour-market distortion: the larger is K the more rapid is
job-creation. Naturally, K is decreasing in h and q, and increasing in p and Dw.
Since each agents lifetime is finite we can focus on the limiting case where there is no
discounting. The job-finding rate at age t, denoted a(t), then becomes (note that we are abusing
the notation by reversing time here),

rK K
at lim for all t 2 0; T : A29
r !0 1 er T t T t
Let F() denote the probability of finding a good job at age t or sooner associated with the hazard
rate a(); this is easily seen to be

T t K
F t 1 for all t 2 0; T : A30
T
The incentive problem determines the rehiring rate for a job-loser, i.e. a worker who has
been fired after being caught misbehaving. (This is a common, but often implicit, feature of
efficiency-wage models of unemployment.) We need to relate this rehiring rate to the hiring
rates of first-job-seekers. Let Nj(t) denote the number of skilled job-seekers of age t in location j,
and let aj(t) denote the (hazard) rate at which these workers find good jobs. The labour
market distortion creates effective job rationing when a job-loser cannot easily be distin-
guished from first-job-seekers. To capture this, assume that a job-loser becomes indistin-
guishable from an average first-job seeker in her cohort in the sense that her rehiring rate
equals the average hiring rate among the current first-job seekers. Hence, for all t 2 [0, T],
P
j1;2 Nj taj t
at P : A31
j1;2 Nj t
We can then show that the number of good jobs created for skilled workers, at any age t, is
proportional to the total number of skilled workers in the cohort and hence does not depend
on their composition in terms of social background. To see this note first that

ai t N_i t=Ni t. Hence
P from (A29) and (A31) we then obtain N_ t=N t K =T t
for all t, where N(t) i1,2Ni(t) is the aggregate number of skilled workers of age t looking
for good jobs. Solving the differential equation yields

T t K
N t N 0; A32
T
where N(0) is the total number of skilled workers in the cohort. Since all vacancies are filled
immediately N_ t is the number of good jobs created for skilled workers of age t, which is
obviously proportional to N(0).
Note that in this model the labour market distortion, and hence the function F(), depends on
the wage gap Dw (though K). While this is true in this particular model we will ignore this link in
the main analysis and will there present comparative statics on Dw and F() separately each with
the other held fixed.
Royal Holloway University of London, CEPR, CESifo and IFS;

Lund University and The Research Institute for Industrial Economics
Submitted: 25 November 2003
Accepted: 13 July 2006
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Anderberg & Andersson (2007) - Stratification, Social Networks in The Labour Market, and Intergenerational Mobility

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Anderberg & Andersson (2007) - Stratification, Social Networks in The Labour Market, and Intergenerational Mobility

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The Economic Journal, 117 (April), 782812. The Author(s). Journal compilation Royal Economic Society 2007.

STRATIFICATION, SOCIAL NETWORKS IN THE LABOUR

Dan Anderberg and Fredrik Andersson

Recent decades have seen a pronounced increase in inequality in many countries,

The Author(s). Journal compilation Royal Economic Society 2007

The Author(s). Journal compilation Royal Economic Society 2007

The Author(s). Journal compilation Royal Economic Society 2007

The Author(s). Journal compilation Royal Economic Society 2007

1.1. Job Creation and Job-finding Rates

1.2. Social Environments and Word-of-mouth Communication

The Author(s). Journal compilation Royal Economic Society 2007

The Author(s). Journal compilation Royal Economic Society 2007

The Author(s). Journal compilation Royal Economic Society 2007

We can also define

1.3. Local Complementarities in Human Capital Investments and Educational Choices

The Author(s). Journal compilation Royal Economic Society 2007

where hj can be interpreted as the maximum idiosyncratic cost borne by someone in

1.4. Locational Choices and House Prices

where zj is the expected earnings (net-of-education-cost) defined in (10). This equation

The Author(s). Journal compilation Royal Economic Society 2007

The Author(s). Journal compilation Royal Economic Society 2007

area. The within-area stability condition guaranteeing unique within-area equilibria is

for all cj 2 [0, 1] which we take to hold throughout.24

2.2. Types of Equilibria

The Author(s). Journal compilation Royal Economic Society 2007

Fig. 1. An Example with One Symmetric and Two Asymmetric Equilibria

The Author(s). Journal compilation Royal Economic Society 2007

2.4. The Nature of the Global Spillover

The Author(s). Journal compilation Royal Economic Society 2007

3. Sustainability of a Non-stratified Equilibrium

We can then show the following result:

that are allocated through word-of-mouth communication. Second, it depends on the

The Author(s). Journal compilation Royal Economic Society 2007

The Author(s). Journal compilation Royal Economic Society 2007

4. Effects on a Stratified Equilibrium

The Author(s). Journal compilation Royal Economic Society 2007

The Author(s). Journal compilation Royal Economic Society 2007

where h(c)G1(c). This cost is strictly convex if

The Author(s). Journal compilation Royal Economic Society 2007

The Author(s). Journal compilation Royal Economic Society 2007

Following the literature we would say that there is perfect mobility if q 0. A

The Author(s). Journal compilation Royal Economic Society 2007

@F2 t F t  F2 t  1  F2 tu tc1 =c2 2 ln1  F2 t

Differentiating (18) that defines the reaction function C() we obtain

Proof of Lemma 3. Consider an increase in waiting times, parameterised by n, such that

The Author(s). Journal compilation Royal Economic Society 2007

Differentiating K(defined in Lemma 2)with respect to n and using (A8) yields

The Author(s). Journal compilation Royal Economic Society 2007

The symmetric equilibrium in contrast is characterised by c C(c ); differentiating immedi-

The Author(s). Journal compilation Royal Economic Society 2007

The Author(s). Journal compilation Royal Economic Society 2007

The Author(s). Journal compilation Royal Economic Society 2007

Royal Holloway University of London, CEPR, CESifo and IFS;

The Author(s). Journal compilation Royal Economic Society 2007

The Author(s). Journal compilation Royal Economic Society 2007

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where h(c)G1(c). This cost is strictly convex if

@F2 t F t F2 t 1 F2 tu tc1 =c2 2 ln1 F2 t

The symmetric equilibrium in contrast is characterised by c C(c ); differentiating immedi-