Are certain cities nice places to live, “consumer cities” in the words of Ed Glaeser, or are they Dickensian, crime-filled hubs useful solely for their aggregation externalities on the production side? Economists have, no surprise, tried to solve that debate. On the one hand, if cities were so great, then why are wages so high, even for unskilled labor? Surely this is a sign that workers are being paid extra to cover the disutility they face from living in a city. On the other hand, if cities were so awful, then why is residential land so expensive? Surely, workers are only willing to pay a premium for an identical house if they enjoy its location.
Economics helps sort out the puzzle. Assume workers can take a job in any city they wish. In equilibrium, their utility, including the utility they receive from non-market quality of life factors, must equate across cities. A place with high quality of life must have relatively high local costs (such as housing) relative to the local wage, once we adjust for demographic and industry characteristics, or more workers would move there. This exercise has been done for decades now, and the results are puzzling: a 2003 estimate of quality of life by states had Wyoming and South Dakota in first and second place. This doesn’t appear to match our intuition. Further, large cities (in the sense of urban areas, not in the sense of core cities) are very strongly associated with low quality of life.
David Albouy has reestimated quality of life in places across the United States, with a few adjustments. First, he adjusts wages for the progressivity of the tax code. High-wage cities are, because of higher marginal tax rates, not so much richer than low-wage cities, hence the unobserved quality of life component of utility in high-wage cities is higher than in an estimate without this adjustment. Second, he notes that the share of spending on local goods (like housing) is higher than that used in previous estimates of quality of life. This means that previous estimates of quality of life are biased against cities with high cost-of-living. Third, he accounts for labor wages per household in a slightly more sophisticated way.
These changes make a big difference. The cities with the highest quality of life, in labor market equilibrium, roughly match your intuition: Honolulu, Santa Barbara, Monterey, San Francisco, San Luis Obispo, Santa Fe, non-metro Hawaii, Cape Cod, San Diego and rural Colorado are highest, while Decatur, IL, Beaumont, TX and Kokomo, IN bring up the rear. Hawaii, California, Vermont and Colorado have the highest QOL among states, while West Virginia, Mississippi, Michigan and Texas have the least. Most of the difference in the quality of life measure is predicted solely by measures of temperate weather, sun, coastal proximity and hilly topography. Large and dense cities, overall, have no lower quality of life than small cities or rural areas; that is, cities are no longer Dickensian, and their cultural amenities balance their congestion-based disamenities. Adjusting these figures for moving costs or heterogeneity makes the above even starker, as both adjustments imply that faster growing cities are, all else equal, higher quality of life than slower growing cities, the intuition being that with heterogeneous tastes for quality-of-life amenities, the next potential migrant values the amenities less than the migrants who have already arrived, hence wages must be higher in faster growing cities with the same quality of life as slower growing cities.
It’s not totally clear to me how we use the results of this estimation, though knowledge for its own sake is certainly worthwhile. It is a great example, though, of how we can use a bit of economic theory to answer seemingly impossible questions like “how valuable is it to live by the sea?” Answers that don’t account for labor market general equilibrium effects, or that rely on survey responses, are far less interesting to me than the type of answer Albouy provides. My strong hunch is that clever empiricists with a good bit of theoretical training can tell us much more about the value of non-market goods that we currently understand.
May 2012 Working Paper (IDEAS version). Albouy notes on his site that this is currently under review for the JPE. (I, and perhaps I alone, find it interesting how “typecast” the major journals in economics are. If you told me this particular paper was potentially coming out at a top journal and asked me to guess, I would tell you “JPE” without a second’s thought. Shall we say that Econometrica is the high theory, AER is diverse but with a recent heavy bias toward experimental in all its guises, ReStud is my favorite kind of old-school applied theory, JPE are articles that the New York Times might write about, and QJE tilts very much toward the empirical style popular at Harvard and MIT?)
A Fine Theorem 
I didn’t read the paper, but this seems to me one of the examples where equilibrium theory with representative agents is quite poor. If we assume diversity, it’s not hard to imagine that there are people who prefer large cities and there are people who prefer small cities, and this will account for a lot of quality of live. Also, there are a lot of path dependency, in the sense that once you born and live in a city for many years, you have tie with lots of people (or not!) that will account for your quality of life.
Best,
Manoel