More vs. less segregated cities but equal welfare: the trade-off effect of information

This paper develops a theoretical model focusing on the effect that different neighborhood compositions can have on the formation of individual beliefs about economic opportunities. Specifically we highlight two effects that spatial segregation may have: (1) it can efficiently separate the individual effort choices of highly and low productive individuals, (2) it may imply that low productive individuals impose a level of redistribution that is too high from the aggregate point of view. The trade-off implies that segregated or non segregated cities may present very similar levels of aggregate welfare. In the paper we also analyze endogenous locations and the equilibrium in the residential market. Because locations influence individual beliefs and effort choices through the information in the neighborhood, we obtain theoretical predictions about the joint dynamics of segregation, spatial mobility, social mobility and income inequality.