Spatial Equilibrium and Measuring Prices without a

Market

Daniel M. Sullivan

Harvard University

April 4, 2015

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 1 / 16
How do you determine prices without a market?

Consider some public policy

I Public school
I Pollution regulation
I Crime reduction
Economic efficiency requires MB = MC
Usually this is achieved via market forces.
I Buyers know their MB, aka Willingness to Pay (WTP)
I Suppliers know their MC
What is the Willingness to Pay for clean air?

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 2 / 16
What is the price of clean air?

What experiment would you design to find the WTP for clean air?

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 3 / 16
What is the price of clean air?

What experiment would you design to find the WTP for clean air?
This is actually an open research question!

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 3 / 16
What is the price of clean air?

What experiment would you design to find the WTP for clean air?
This is actually an open research question!
One idea is to use the idea of spatial equilibrium and house prices.

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 3 / 16
Spatial Equilibrium

Suppose that you’re choosing what neighborhood (or city or state) to

live in.
Your utility from living in a given place is determined by

Utility = Income + Amenities − House Price

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 4 / 16
Spatial Equilibrium

Suppose that you’re choosing what neighborhood (or city or state) to

live in.
Your utility from living in a given place is determined by

Utility = Income + Amenities − House Price

Two cities: Los Angeles and New York. Let’s say that both cities have
the same income opportunities, amenities, and house prices.
I What happens if firms in New York start offering higher wages?
I In the long run, who is better off, people living in LA or New York?

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 4 / 16
Spatial Equilibrium

1 Wages in New York increase.

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 5 / 16
Spatial Equilibrium

1 Wages in New York increase.

2 People move from LA to New York. . .

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 5 / 16
Spatial Equilibrium

1 Wages in New York increase.

2 People move from LA to New York. . .
3 People need somewhere to live! House prices increase. (Supply and
demand)

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 5 / 16
Spatial Equilibrium

1 Wages in New York increase.

2 People move from LA to New York. . .
3 People need somewhere to live! House prices increase. (Supply and
demand)
4 House prices increase until people stop moving to New York.

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 5 / 16
Spatial Equilibrium

1 Wages in New York increase.

2 People move from LA to New York. . .
3 People need somewhere to live! House prices increase. (Supply and
demand)
4 House prices increase until people stop moving to New York.

If people in LA don’t want to move to NY, and people in NY don’t

want to move to LA, what must be true?

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 5 / 16
Spatial Equilibrium

1 Wages in New York increase.

2 People move from LA to New York. . .
3 People need somewhere to live! House prices increase. (Supply and
demand)
4 House prices increase until people stop moving to New York.

If people in LA don’t want to move to NY, and people in NY don’t

want to move to LA, what must be true?

UtilityNY = UtilityLA

This is a Spatial Equilibrium.

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 5 / 16
Spatial Equilibrium
Getting a dollar value

Let’s ignore income for now. If we have spatial equilibrium, then

UtilityNY = UtilityLA
AmenitiesNY − House PriceNY = AmenitiesLA − House PriceLA
What happens if LA enacts tougher air pollution regulations (an
amenity improvement)?

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 6 / 16
Spatial Equilibrium
Getting a dollar value

Let’s ignore income for now. If we have spatial equilibrium, then

UtilityNY = UtilityLA
AmenitiesNY − House PriceNY = AmenitiesLA − House PriceLA
What happens if LA enacts tougher air pollution regulations (an
amenity improvement)?

AmenitiesNY − House PriceNY = AmenitiesLA − House PriceLA

| {z } | {z } | {z }
No change Increase Increase

If we measure the changes in Amenities and House Prices, we can

calculate society’s willingness to pay.

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 6 / 16
Spatial Equilibrium
Getting a dollar value

If we measure the changes in Amenities and House Prices, we can

calculate society’s willingness to pay.

House Price House Price ($) $

= 3
=
Amenity Pollution (µg/m ) µg/m3

Yields “dollars per unit of pollution”, aka marginal benefit!

This is true not just across cities, but across individual houses within
a city.

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Measuring the value of clean air
Pollution in LA

Now that we have the theory, it’s time for empirics.

In 2000, California went through an energy crisis.
Some electricity generators ramped up production (and pollution) to
prevent blackouts.
This triggered a sort of regulatory fail safe.

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 8 / 16
 0.9 0.65
0.8
0.60
0.7

Scaled NOx (non-electric)

0.6 0.55
Scaled NOx (electric)

0.5
0.50
0.4
0.3 0.45
0.2
0.40
0.1
0.0 0.35
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Year
Electric Non-electric
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Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 10 / 16
Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 11 / 16
Crunch the numbers

A 1 unit decrease in pollution causes house prices to increase by 1.7%

−0.017
| {z }
× −1.5 µg/m3 × $350,000 ≈ $9,000
| {z } | {z } | {z }
%∆p per NOx Avg. ∆NOx p̄ in 2000 (2010$) Gain per house

Daniel M. Sullivan (Harvard University) Spatial Eq. and Prices April 4, 2015 12 / 16
Crunch the numbers

A 1 unit decrease in pollution causes house prices to increase by 1.7%

−0.017
| {z }
× −1.5 µg/m3 × $350,000 ≈ $9,000
| {z } | {z } | {z }
%∆p per NOx Avg. ∆NOx p̄ in 2000 (2010$) Gain per house

300,000 houses in the sample area.

Total value of $2.7 billion.
What does this mean in terms of cost vs. benefits?

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Bonus: Value of Crime
Linden and Rockoff (2008) American Economic Review

Consider a neighborhood defined by a circle of radius r1

r1

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Bonus: Value of Crime
Linden and Rockoff (2008) American Economic Review

Suddenly, a known criminal moves into the neighborhood and

announces the fact to every house less than r 0 away.

r1 r0

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Bonus: Value of Crime
Linden and Rockoff (2008) American Economic Review

Before the shock, compare house values inside r0 to houses between

r0 and r1 .
Do it again after the shock to get the how much value was lost
because of the criminal.

r1 r0

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Bonus: Value of Crime
Linden and Rockoff (2008) American Economic Review

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