The Law of Demand in Tiebout Economies
We consider a general equilibrium local public goods economy in which agents have two distinguishing characteristics. The first is 'crowding type,' which is publicly observable and provides direct costs or benefits to the jurisdiction (coalition or firm) the agent joins. The second is taste type, which is not publicly observable, has no direct effects on others and is defined over private good, public goods and the crowding profile of the jurisdiction the agent joins. The law of demand suggests that as the quantity of a given crowding type (plumbers, lawyers, smart people, tall people, nonsmokers, for example) increases, the compensation that agents of that type receive should go down. We provide counterexamples, however, that show that some agents of a given crowding type might actually benefit when the proportion of agents with the same crowding type increases. This reversal of the law of demand seems to have to do with an interaction effect between tastes and skills, something difficult to study without making these classes of characteristics distinct. We argue that this reversal seems to relate to the degree of difference between various patterns of tastes. In particular, if tastes are homogeneous, the law of demand holds. This paper is to appear in a volume on Tiebout economies, to be published by the Lincoln Institute.