expect a high-cost district to achieve the same performance as other districts unless it is given enough resources to compensate for high costs.
In the case of education, the most important input is teachers, so in constructing a cost index, it is vital to account for teachers' salaries. Secondary inputs, such as school facilities, also play a role in delivering education, but data on the prices of these inputs are generally not available. In some cases, data on administrators' salaries are available, but these salaries are so correlated with teachers' salaries that they add little to the analysis. Like almost all the literature, therefore, we will restrict our attention to the role of teachers' salaries.
A cost index is designed to measure the impact of factors outside the control of school officials. It is not appropriate, therefore, to directly use actual teachers' salaries in constructing a cost index because those salaries reflect both the generosity of the school district, a factor over which they have control, and the underlying labor market conditions, which cannot be influenced by school officials. A cost index should reflect the fact that some school districts are located in high-wage labor markets, where they must pay high salaries to attract people away from other school districts or away from the private market; and it should reflect the fact that the external conditions in some school districts are so harsh that teachers will not come there without receiving "combat pay"; but it should not reflect the fact that some school district administrators pay higher salaries than necessary to attract their teachers, because they are poor negotiators or for any other reason.
A cost index should not be affected by school districts' choices, so the influence of school officials on teachers' salaries poses a challenge to anyone who wants to construct a cost index. Fortunately, however, well-known statistical procedures can separate the impact of school officials on teachers' salaries from the impact of external factors and produce a cost index based only on factors outside the control of school officials. These procedures are discussed in a later section.
The home comfort example reveals that the cost of meeting a performance standard depends not only on input prices but also on the environment in which the relevant services are provided. This lesson carries over into education, as school districts with a harsher educational environment must pay more to obtain the same educational performance as other districts. This section explains the impact of environmental factors on educational costs and shows how this impact can be estimated using widely available data.
The key role of environmental factors, also called fixed inputs in the literature,