Estimating the demand for non-marketed goods such as school quality poses challenging endogeneity and selection problems, given that households sort across neighborhoods non-randomly. To address these problems, this paper develops a comprehensive new approach for recovering a broad set of preferences for school and neighborhood attributes, modeling the sorting process directly and providing a new strategy for dealing with the endogeneity that arises when sorting is influenced by unobservable choice characteristics. We estimate the model using rich data on a large metropolitan area, drawn from a restricted version of the Census. The estimates indicate that, on average, households are willing to pay an additional one percent in house prices – substantially lower than in prior work – when the average performance of the local school is increased by 5 percent. There is also evidence of considerable preference heterogeneity. Using our equilibrium framework to explore the general equilibrium implications of these estimates, we show that the full capitalization of school quality into housing prices is typically 70-75 percent greater than the direct effect. This is the result of a social multiplier, neglected in the prior literature, whereby increases in school quality also raise housing prices by attracting households with more education and income to the corresponding neighborhood.
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