Chapter 1

1. Introduction and Axioms of Urban Economics Chapter 1

2. Urban Economics • Urban economics combines both economics and geography: • Economics explores how people make decisions under scarcity, while • Geography explains where human activity occurs. • Urban economics explores the location choices of maximizing agents.

3. Areas of Urban Economics • Market forces within the development of cities • Land use • Urban transportation • Crime and Public Policy • Housing and public policy • Local government expenditure and taxes

4. Urban Area • Urban area is defined based on population density, the number of people living in a given area. • An urban area has a high population density relative to surrounding areas. (Can agriculture be the prominent activity in cities?) • Therefore, in an urban area there is frequent contact between different economic activities.

5. For a city to develop Three conditions have to be satisfied for a city to develop • The first condition: • Agricultural surplus • The rural dwellers must produce enough food to provide for themselves as well as city dwellers.

6. For a city to develop • The second condition: • Urban production • City dwellers must produce something to exchange with rural people for the food they grow.

7. For a city to develop • The third condition: • Transportation for exchange • An efficient network of transportation has to exist to facilitate the exchange of food and urban products.

8. The rise of an urban society • We will see later that the transformation from a rural to an urban society was facilitated by technological advances that: • increased agricultural surplus, • Increased the productivity of urban workers, and • Increased the efficiency of exchange and transportation.

9. Five Axioms of Urban Economics

10. 1. Prices adjust to achieve locationalequilibrium • Locational Equilibrium is achieved when given the prices of different locations every one is satisfied with his location, i.e. no incentive to move. • Prices adjust so people are indifferent between desirable and undesirable locations.

11. 2. Self Reinforcing Effects Generate Extreme Outcomes • A change in something leading to additional changes in the same direction. • Example: Concentration of automobile sellers in a certain area makes the area more attractive for other automobile sellers to locate, resulting in more concentration.

12. 3. Externalities Cause Inefficiency • When benefits or costs of a transaction fall on a third party, the market outcome is socially inefficient.

13. Marginal Social cost (MPC+ external cost) Tax= External Cost Supply (MPC) Optimum Equilibrium Demand (MPB) QWELFARE QMARKET Pollution and Market Inefficiency Price of Aluminum Quantity of 0 Aluminum

14. 4. Production is Subject to Economies of Scale • Economies of scale occur when doubling all inputs of production results in more than doubling output.

16. Economies of scale occur for two reasons: • Indivisible inputs: when capital inputs are lumpy and cannot be scaled down for small operations.

17. Economies of scale occur for two reasons: • Factor specialization: dividing production into smaller tasks each undertaken by few workers. This is possible with a large scale of production.

18. Scale Economies and cost • When there are economies of scale in production, the average cost of production decreases as output increases. AC AC AC Q Q Q

19. 5. Competition Generates Zero Economic Profit • In the absence of barriers to entry, we expect firms to enter a market until economic profit is zero. • This implies that the factors of production are earning their opportunity costs, i.e., just enough to keep them in business. In that case they are earning normal profit

20. Example • Adam decided to open a bakery. He could earn $50,000/ year in another job. He withdraws his savings from the bank, $100 000 , which was earning 7%. The market for baked goods is a perfect competitive market • After paying all his expenses how much money do you expect Adam to be making in a year?