URBAN ECONOMICS

1. URBAN ECONOMICS SPRING 2010

2. Why do cities exist?

3. 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?

4. Let’sbuildup a model… • Assumptions: • Theregionproducesandconsumestwogoods: shirtsandbread. 2. Peopleuselandtogrowrawmaterialsandtake time totransformrawmaterialsintoshirtandbread. 3. Travelwithinthisregion is byfoot. Residentswalk at a speed of 8 kmsperhour.

5. Assumptions (which prevent the formation of cities): • Equalproductivity. • No scaleeconomies in production. • No scaleeconomies in transportation.

6. Consequences of these assumptions • There is no possibility of trade. Each person is self-sufficient. • No specialization. • No scale economies. • Population will be uniformly distributed throughout the region.

7. Relaxing the assumptions to form a city Assumption 1 : Equal productivity 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:

8. Relaxing the assumptions to form a city South has a comparative advantage in production of bread. North has a comparative advantage in production of shirts.

9. Relaxing the assumptions to form a city Result: Specialization and trade But, a city does not exist yet….

10. Relaxing the assumptions to form a city Assumption 2 : No scaleeconomies in transportation But, if transport costper km. decreases as thevolumetransportedincreases, it would be cheaperto transport shirtsandbread in bulks. Thisalsocreatesintermediariesin transportation. Whataretheimplications?

11. Relaxing the assumptions to form a city Thetradingfirmswilllocate at placesconvenientforthecollectionanddistribution of goods. Hence, marketplacesdevelop at crossroads, portsandothershipmentpoints. Thelocationdecisions of thetradingfirmscausethedevelopment of marketcities. Themarketplacewillcreateemploymentopportunities. Theemployeeshiredbytradingfirmswilllivenearmarketplacetoeconomize on commutingcosts.

12. Relaxing the assumptions to form a city 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.

14. Relaxing the assumptions to form a city Assumption 2 : Constantreturnstoscale in production Supposethatproduction is subjecttoconstantreturnstoscale. Thismeans, eachworker can produceeither 1 shirtor 1 breadperhourregardless of howmuch he/sheproduces: Thereare no advantagesfromproducing at largescales. Ifwerelaxthisassumption, thenfactoryproductionmayreplacehomeproduction. How?

15. 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 Average labor time Number of shirts

16. Whydoestheaveragelabor time decrease as number of shirtsproducedincreases? • Factorspeacialization: Eachlaborerspecializes in onetaskandtheirproductivityincreases. • Indivisibleinputs: Someinputsareindivisible since theyhaveminimum efficientscale. E.g. Machines in a factory. Theycannot be scaleddownefficientlyforusebyindividualworkers. As outputincreasesfactoryusesmoreindivisibleinputshenceproductivityincreases.

17. Initially: 1 hr 1 shirt Now: 0.25 hr 1 shirt (or 1 hr 4 shirts) Whatshould be thewagelevelandprice of a shirt? Wageshould be at leastas high as tomakeworkersindifferentbetweenworking in thefactoryandworking at home. Iftheworkerworks at home: He/sheproduces 1 loaf of bread/hr. Iftheworkerworks at thefactory: He/sheproduces 4 shirts/hr. Hence, minimum wageshould be 1 loaf of bread/hr.

18. Then, 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).

19. A resident can produce 1 loafperhr. Itwill be sensibleto buy a factoryshirtif net price of a factoryshirt is at most 1 loaf. Since, productioncost is equalto 0.25 loaf, theconsumershouldconsiderthe time that a triptakes. 0.25 + trip time= 1 Thentrip time can be at most 0.75 hr. If it is lessthan 0.75, theconsumerwillprefer a factoryshirt.

20. Supposethatwalking time is 8 kmsperhour. Accordingtothesecriteria, themarket areaof theshirtfactory is determined. It is theareaforwithinwhichthefactorywillunderpricehomemadeshirtsforresidents. Inourcase, it is defined as theareawithin 3 ks of thefactory. Why? (We can have at most 0.75 hrswalking time, thismeans since walking time is 8 kms/hr, we can have 6 kmsfortwowaywalking –toandfromthefactory-. That is whyweendupwith a circlewith a radius of 3 kms).

21. Factory causes the development of a small factory city.

22. Are there any limits to city size? • Freightcost: Wehaveassumedthatconsumerstravelbetweenhomeandfactorymeaningtheytheythemselvesincurfreightcosts. Thiscost of transportinggoodslimitstheability of thefactorytoexploiteconomies of scale in production. What can thefactory do? Weknowthattravelspeed is 8 kms/hr. and market area is a circlewith a radius of 3 kms. Ifthefirmbecomesresponsiblefromfreightcostsandcreates a methodtoincreasethetravelspeed, then it can create a greater market area. E.g. Ifthefirmincreasesthetravelspeedto 16 kmsperhr (doubles), market areawill be a circlewith a radius of 6 kms. Thiswillincreasetheoutput of thefactory, factory’sworkforceandpopulation of thefactorycity.

23. Are there any limits to city size? • 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…

24. Are there any limits to city size? 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.

25. Are there any limits to city size? 3. Commuting costs: Larger cities have larges commuting times. In larger cities factory must pay workers to compansate for longer commuting times. Since market area is determined according to the net price of the factory shirts, increase in wages is a limit to the city size. Inverse may also apply: A decline in the unit cost of commuting will cause a city to grow.

26. E.g. Boston A rule of thumb: A city should be small enough that a resident can travel from one edge of the city to the city center in an hour. Boston is a good example of the effects of changes in transit technology on city size. 1850 : Boston was a small walking city with a radius of 2 miles. 1860s: Horse-powered railroad; city radius: 2.5 miles. 1887: 4 miles. 1890: Electric trolley: Speed and number of passengers doubled.City radius: 6 miles. Last 40 years: Radius is tripled and land area increased ninefold.

27. Summary Whatdidwelearntoday? Economicforcesbehindthedevelopment of cities: • Comparativeadvantage • Economies of scale in transportation • Economies of scale in production Determinants of city size.