The Market for Peers ∗

Empirical estimates of peer effects vary widely in the literature. To better understand the conflicting evidence, we develop a price theory of social interactions in which peer group membership is dictated by comparative advantage. Two key results emerge from the model. First, when comparative advantage is the guiding principle of peer group organization, the effect of transplanting a student into an environment with higher-achieving peers depends on where in the ability distribution she falls and the effective wages that clear the social market. Second, since social wages and a student’s comparative advantage are typically unobserved, the theory implies that important determinants of individual choice operate through the error term and may, even under random assignment, be correlated with the regressor of interest. As a result, under the assumptions of our model, linear in means estimates of peer effects are not identified. We show that the model’s testable prediction in the presence of this confounding issue–an individual’s ordinal rank predicts her behavior, ceteris paribus–is borne out in two data sets. ∗We are grateful to Edward Glaeser, Bryan Graham, Richard Holden, Lawrence Katz, Steven Levitt, Franziska Michor, Chris Shannon, Andrei Shleifer, Glen Weyl, and seminar participants in the Harvard Labor Lunch for helpful comments and suggestions. We thank Lisa Sanbonmatsu for her assistance obtaining data from the Moving to Opportunity Experiment, which were used in an earlier draft of this paper. Vilsa E. Curto, Ryan Fagan, and Wonhee Park provided excellent research assistance. Financial support from the Weatherhead Center for International Affairs [Cicala], the Education Innovation Lab at Harvard University [Fryer], and the German National Academic Foundation [Spenkuch] is gratefully acknowledged. Correspondence can be addressed to the authors at Department of Economics, Harvard University, 1805 Cambridge Street, Cambridge MA 02138 [Cicala or Fryer]; Department of Economics, University of Chicago, 1126 E 59th Street, Chicago IL 60637 [Spenkuch]; or by e-mail: [email protected] [Cicala], [email protected] [Fryer], or [email protected] [Spenkuch]. The usual caveat applies.