was first identified in the Coleman Report (Coleman et al., 1966), which showed that a student's performance on standardized tests depended not only on his or her own characteristics and family background but also on the characteristics and backgrounds of the students in his or her class. All else equal, for example, a student's performance is likely to be lower if she comes from a poor family or if a large share of her classmates come from poor families. This finding translates into a statement about educational costs. If performance declines as student poverty increases, then a district with a high poverty rate cannot achieve the same performance as a district with a low poverty rate without running programs (which, of course, cost money) to offset the impact of poverty.

The important role of environmental factors in educational production has been verified by dozens of studies. A review of many early studies is provided by Hanushek (1986). Good recent studies, such as Ferguson (1991), Ferguson and Ladd (1996), and Krueger (1997), use school and student-level data, and provide a more detailed analysis of the relationship between the student/family characteristics and student performance. The study by Ferguson and Ladd, for example, finds that a student's 4th-grade educational performance (on reading and math tests) is affected by, among other things, the share of students receiving a free lunch (a measure of poverty), the share of adults in the district with a college degree, a measure of student turnover, and district enrollment. These studies are analogous to engineering studies that link detailed weather conditions and indoor comfort in each type of house.

Production studies focus on the impact of environmental factors on a measure of performance, such as a test score, holding-constant inputs selected by the school, such as the student/teacher ratio. These studies imply that costs are higher in school districts with a harsher educational environment, but do not estimate cost differences directly. Moreover, the results of these studies vary significantly, depending on the methodology, the quality of the data, and other factors, so that even if the results were translated into cost differences across districts, these differences would vary widely from one study to the next.

Another set of studies shifts the focus to educational costs. These studies, which are analogous to a study of spending for home heating across a sample of communities, determine the extent to which districts with a harsh educational environment, as measured by the characteristics of their students, must pay more to achieve the same performance as other districts, where performance is measured by a set of performance indicators. These studies include Bradbury et al. (1984), which looks at all local spending, including spending on education, as well as studies by Ratcliffe et al. (1990), Downes and Pogue (1994), Duncombe et al. (1996), and Duncombe and Yinger (1997). These studies build on a well-known general treatment of environmental factors by Bradford et al. (1969).

At one level, these cost studies are equivalent to production studies; any statement about production can be translated into a statement about costs and vice versa. In practice, however, the cost approach has several advantages over the



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