Wages, rents, and heterogeneous moving costs

Abstract

The model of compensating differentials in regional labor and land markets was formalized by. The model interprets regional differences in constant quality wages and rents as compensating firms and residents for inter-regional differences in amenities. This paper extends the Roback model to allow for moving costs which vary among a city's residents and businesses. This modification of the model generates new interpretations of regional differences in rents and wages. The theoretical results suggest that the interpretation of inter-city rent and wage differentials as compensating is misguided, that such differentials are inappropriate as weights in Quality of Life (QOL) comparisons, and stresses the importance of local housing market parameters in the determination of these differentials. The importance of amenities is retained, but housing supply becomes the main other determinant of regional rents. Housing supply was ignored in the literature following on Roback's initial insight. We show that interactions between amenities and housing supply will bias QOL rankings. Finally, we support the empirical importance of heterogeneous moving costs by demonstrating the effects of exogenous supply constraints on local housing prices. © 2012 Western Economic Association International.