A large and growing gap in educational outcomes between urban and rural areas has emerged, with major implications for the future of rural students. However, previous research has not investigated the causes of this gap. We examine whether and how 'peer effects' can explain this educational gap, and the implications for students from different social backgrounds. Peer effects mean that school students influence each other, positively through e.g. engagement in school work or helping each other, or negatively through e.g. messiness, bullying and fewer role models in the classroom. However, empirical research on peer effects in Swedish schools is still limited, despite its relevance in research, education policy and public debate. We use extensive register data on students, parents, school classes, teachers and schools in all schools since 1987 to study how classmates in the grade or school class affect students' grades, upper secondary school choices, and whether they go to university, and how this differs between urban and rural areas. To isolate the causal impact of peer effects on grade outcomes and future study choices, we use sibling comparisons and instruments for the parental background of peers.