Workings of a City: Location, Education, and Production

We examine the links between residential choice, human capital investment, and production, in a city composed of several communities where the acquisition of different skills is subject to peer goup effects. The equilibrium involves maximal self-segregation by occupation, whereas Pareto efficiency may require identical communities. The inefficiency can even cause entire "ghettos" to drop out of the productive labor force. Underemployment is more extensive, the easier it is for highskill workers to isolate themselves from their lowskill counterparts. When perfect segregation is feasible, individual incentives to pursue it are self-defeating, and lead instead to a total shutdown of the productive sector.