There is a large literature which documents a significant increase in wage inequality from 1980 to 2000 (Katz & Autor, 1999). The growth in wage gap between high school and college graduates has been particularly large, at 21%. Since wage income is a large contributor to a householdks economic well being, it is tempting to view income inequality as a measure of welfare inequality. During this time period, there has been sharp changes in the relative distribution of college graduates and lower skill workers across metropolitan areas in the US. For example, the share of the working population living in Boston who have a college degree has increased 17 percentage points during this 30 year time span.
Using Census data, I show that from 1980 to 2000 college graduates have increasingly concentrated in metropolitan areas with higher prices for housing and local goods. However, the welfare implications of this fact are ambiguous. High prices for housing and goods offset some of the wage premium enjoyed by college graduates, implying that the observed wage distribution could overstate the growth in the college welfare gap. On the other hand, high local prices can be driven by the value of citiesknon&market amenities such as weather, cleanliness, crime levels, and school quality.
The utility value of these amenities can compensate workers for local price levels. Accounting for the amenity value of cities could cause observed wage inequality to understate welfare inequality because higher earning workers also can afford to enjoy better non market amenities. Moretti (2011) was the first paper to make this point. As pointed out by the standard Rosen Roback model (1982), differences in citiesklocal productivity levels, as well as how city inhabitants value amenities, effect the wages and housing prices of the local labor and housing markets. Since different cities offer different amenities, local prices, and wages to its inhabitants, the value of these costs and benefits must all be taken into account to understand the welfare implications of increasing wage inequality.
