Event Recap: The Micro Foundations of Macro Sorting Models

Oct. 23, 2012
On Monday, October 22, 2012, Daniel Phaneuf, Associate Professor in the Department of Agricultural and Applied Economics at the University of Wisconsin-Madison, presented his recent research focused on “The Micro Foundations of Macro Sorting Models” for the Havlicek Memorial Seminar as part of the 2012 AEDE Seminar Series.
Phaneuf, who also serves as the Managing Editor of the top journal in the field of environmental economics, the Journal of Environmental Economics and Management, presented research that he and Timothy L. Hamilton, a former student who is now at the University of Richmond, have worked on together.  Using the theory of two-stage budgeting, Phaneuf and Hamilton examine household decision making in regards to consumers’ choices of city to reside in and neighborhood choice within their chosen city. The researchers are interested in learning how these two choices are interconnected and what this connection might mean for how economists use sorting models to value public goods, such as air quality. To conduct their research Phaneuf and Hamilton used US Census Data from 1990 and 2000 focused on household heads between the ages of 23 and 40 who live in one of 226 metropolitan statistical areas in the continental United States.
As Phaneuf and Hamilton note in their research, “Households first select a metropolitan area or region and then, conditional on this macro level choice, they select a specific neighborhood. The macro choice may depend on labor market considerations and regionally varying geographical aspects such as climate; the micro (or neighborhood) choice might depend on school quality or access to landscape amenities. Although distinctive, it is possible that the two choice levels may be interconnected. For example, good regional air quality might enhance the attractiveness of outdoor amenities at the local level. In contrast poor regional air quality might decrease the importance of outdoor amenities while placing a premium on easy access to high quality health care facilities. Thus variation in access to complementary or substitutable local public goods might affect households’ valuations for regionally varying amenities.”
This research is important as all previous sorting models used in the field have operated at the macro level or the micro level – they have analyzed a single choice from a single set of alternatives. However, as the researchers note regarding their interest in this research area, “Intuition suggests that households choose a city and subsequently select a neighborhood within that city.” To date, no conventional sorting models have taken this logic into consideration, which Phaneuf and Hamilton attempt to add to the field. They do this through the implementation of a two-stage budgeting model to develop a sorting model that more accurately replicates the household decision making process in regards to city and neighborhood choice. To test how micro level choices affect macro level valuation, the researchers used a nested logit model that focused on households’ marginal willingness to pay for regionally varying air quality.  
Using the two-stage model the researchers found differing results in comparison to conventional sorting models, which showed that in their study group households made a tradeoff between air pollution and neighborhood-level amenities – or in other words, the households showed a marginal willingness to pay for clean air. As the researchers note, “In our preferred model the elasticity of willingness to pay with respect to air quality is 0.48. By way of comparison we find an elasticity of 0.31 for a conventional model that does not account for micro-level sorting. At median levels of income and air pollution these estimates translate to annual marginal willingness to pay predictions of $232 and $371, respectively.”
The two-stage model adds significantly to the field enabling researchers to evaluate in more depth consumer decision making in regards to public goods, “Taken together our results suggest that the macro and micro dimensions of sorting behavior are connected in ways that can have economically significant effects on valuation measures.”
To see Phaneuf’s full presentation, please click here.
The Havlicek Memorial Seminar is sponsored by funds from the Havlicek Memorial Fund, which honors Joseph Havlicek, Jr., former AEDE Professor and Chair. Professor Havlicek, who was at different points in his well-accomplished life, a student, a faculty member, a leader and a researcher at Ohio State, focused on price analysis and applied econometrics in his career. The yearly seminar named after him focuses on new research in this field to continue Professor Havlicek’s dedication to this topic of study.

October 24, 2012