URBAN ECONOMICS

SPRING 2008

Why do cities exist?

• Cities are places in which population density is greater than the other parts of the countries.

• In an economic context, what are the factors behind the creation of the cities?

• Let’s build up a model…• Assumptions: 1.The region produces and consumes two

goods: shirts and bread.

2. People use land to grow raw materials and take time to transform raw materials into shirt and bread.

3. Travel within this region is by foot. Residents walk at a speed of 8 miles per hour.

• Suppose that:1. All residents are equally productive at producing

bread and shirts. Similarly all land is equally productive in production of raw materials.

This assumption implies that there is no room for comparative advantage. Since all residents are equally productive at producing bread and shirts, there is no advantage of trading.

• If we relax this assumption, i.e. one part of the region may have a comparative advantage in shirt production and the other part may have a comparative advantage in bread production.

• Let’s say that the region has two parts: South and North. The production amounts in each region are given below:

Output per hr (of a worker) Opportunity Cost

South North South North

Bread 1 2 1 shirt 3 shirts

Shirts 1 6 1 bread 1/3 bread

South has a comparative advantage in production of bread.

North has a comparative advantage in production of shirts.

2. Suppose that there are no scale economies in transportation. Transport cost per unit of shipped per mile is independent of the volume shipped.

But, if transport cost per mile decreases as the volume transported increases, it would be cheaper to transport shirts and bread in bulks. This also creates intermediaries in transportation.

What are the implications?

The trading firms will locate at places convenient for the collection and distribution of goods. Hence, marketplaces develop at crossroads, ports and other shipment points.

The location decisions of the trading firms cause the development of cities. The marketplace will create employment opportunities.

The employees will live near marketplace to economize on commuting costs.

Hence, demand for land near marketplace increases: Price of land increases.

Residents will economize by occupying smaller lots.

As a result, population density around the marketplace will be higher than the rest of the region.

3. Suppose that production is subject to constant returns to scale. This means, each worker can produce either 1 shirt or 1 bread per hour regardless of how much he/she produces: There are no advantages from producing at large scales.

If we relax this assumption, and impose assumption of scale economies, then factory production may replace home production. How?

• If there are scale economies (instead of CRTS) in production, as volume of shirt production increases, labor required to produce one shirt decreases (less input per unit of output, costs decline with output).

Labor time/shirt

Number of shirts

Average labor time

• Why does the average labor time decrease as number of shirts produced increases?

1.Factor speacialization: Each laborer specializes in one task and their productivity increases.

2.Indivisible inputs: Some inputs are indivisible since they have minimum efficient scale. E.g. Machines in a factory. As output increases factory uses more indivisible inputs hence productivity increases.

If the shirt factory produces 400 units with 100 workers and 4 shirts per worker per hour:

What should be the wage level and price of a shirt? Wage should be at least as high as to make workers

indifferent between working in the factory and working at home.

If the worker works at home: He/she produces 1 loaf of bread/hr.

If the worker works at the factory: He/she produces 4 shirts/hr.

Hence, minimum wage should be 1 loaf of bread/hr.

Since each worker produces 4 shirts/hr, assuming that there are no other costs, production cost of one shirt is 0.25 loaf of bread.

Net price of a factory shirt:Price paid by consumer to firm (0.25 loaf)

+Consumer’s opportunity cost of the time spent

traveling to and from the factory(Loss of bread production due to traveling instead of producing bread).

A resident can produce 1 loaf per hr. It will be sensible to buy a factory shirt if net price of a factory shirt is at most 1 loaf.

Since, production cost is equal to 0.25 loaf, the consumer should consider the time that a trip takes.

0.25 + trip time= 1 Then trip time can be at most 0.75 hr.If it is less than 0.75, the consumer will prefer a

factory shirt.

Suppose that walking time is 8 miles per hour.According to these criteria, the market area of the

shirt factory is determined.It is the area for within which the factory will

underprice homemade shirts for residents.In our case, it is defined as the area within 3 miles

of the factory.Why? (We can have at most 0.75 hrs walking time,

this means since walking time is 8 miles/hr, we can have 6 miles for two way walking –to and from the factory-. That is why we end up with a circle with a radius of 3 miles).

Factory causes the development of a small factory city.

• Are there any limits to city size?1. Freight cost: We have assumed that consumers travel

between home and factory meaning they they themselves incur freight costs. This cost of transporting goods limits the ability of the factory to exploit economies of scale in production.

What can the factory do? We know that travel speed is 8 miles/hr. and market area

is a circle with a radius of 3 miles. If the firm becomes responsible from freight costs and

creates a method to increase the travel speed, then it can create a greater market area.

E.g. If the firm increases the travel speed to 16 miles per hr (doubles), market area will be a circle with a radius of 6 miles. This will increase the output of the factory, factory’s workforce and population of the factory city.

• Decrease in freight cost allows factory to more fully exploit economies of scale, increasing city size.

• Transportation is a very important factor affecting the city size.

• Think about examples from Turkey, Europe…

2. Scale economies: As economies of scale beacome more powerful, cost of factory production decreases relative to home production.Hence, market area of the factory increases and size of factory cities increase.

Think about the industrial revolution: Spinning jenny to the machines.

Several inventions in textile machinery occurred in a relatively short time period during the industrial revolution: the flying shuttle, spinning jenny, spinning frame, and cotton gin. These inventions facilitated the handling of large quantities of harvested cotton. In 1764, a British carpenter and weaver named James Hargreaves invented an improved spinning jenny, a hand-powered multiple spinning machine that was the first machine to improve upon the spinning wheel.

3. Commuting costs: Larger cities have larges commuting times.

In larger cities factory must pay workers to compansate for longer commuting times.But as wages increase, cost of factory shirts increase relative to homemade shirts.

Since market area is determined according to the net price of the factory shirts, increase in wages is a limit to the city size.

What can be done?

Metro, easier transportation methods, etc.