“zwu001070402 ” — 2007/1/24 — page 122 — #1 DISCRETE CHOICE WITH SOCIAL INTERACTIONS AND ENDOGENOUS MEMBERSHIPS

This paper is about selection of neighbors in models of social interactions. I study a general equilibrium model of behavior subject to endogenous social influences when heterogeneous individuals can choose whom to associate with, buying associations on a “memberships mar-ket”. Social effects in behavior turn out to be a stratifying force: The desire for valuable interactions induces inefficient sorting and may lead to the endogenous emergence of “social traps”. The theory is then used to suggest identification strategies that may solve, in a micro-founded way, identification and selection problems that typically affect empirical work on social interactions. Such strategies offer a viable alternative when valid instrumental variables or randomized experiments are not available. (JEL: C26, D85, Z13, Z19) To choose a neighborhood is to choose neighbors