Week 3 Lesson2

7/28/2019 Week 3 Lesson2

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McGraw-Hill/Irwin

2009 The McGraw-Hill Companies, All Rights Reserved

Introduction and Axioms of

Urban Economics


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2009 The McGraw-Hill Companies, All Rights Reserved 1-2

Urban economics combines both economics and

geography

Economics explores how people make decisionsunder scarcity, while

Geography explains where human activity ocurs

Urban economics explores the location choices of

maximizing agents

Urban Economics: Economics meetsgeography


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Why do cities exist?

Why do competing firms cluster?

Why do cities vary in size?

What causes urban growth and decline?

Who benefits from urban growth?

Market forces in the development of cities


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Place with a relatively high population density

Census definitions

Urban area: minimum population = 2,500

Urban population: people living in urban areas

Metropolitan area: at least 50k people

Micropolitan area: 10k to 50k people

Principal city: largest municipality in metro area

What is a City?


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Conditions for cities

Agricultural surplus

Urban production to exchange for food

Transportation system for exchange

Facts on cities: Figure 1-1, 1-2, 1-3; Tables 1-1, 1-2

Why Do Cities Exist?


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Five Axioms to Know About

Urban Economics Economic theory is based on a few

assumptions or axioms.

These axioms are a list of conditions that

must be true for the theory to be correct.

They are five axioms in urban economics


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Urban AreaUrban area is defined based on population density,

the number of people living in a given area.

An urban area has a high population density relativeto surrounding areas. (Can agriculture be theprominent activity in cities?)

Therefore, in an urban area there is frequent contactbetween different economic activities.


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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 enoughfood to provide for themselves as well as

city dwellers.


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The second condition:

Urban production

City dwellers must produce

something to exchange with rural

people for the food they grow.


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The third condition:

Transportation for exchange

An efficient network of transportation

has to exist to facilitate the exchange

of food and urban products.


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The rise of an urban society

We will see later that the transformation

from a rural to an urban society was

facilitated by technological advancesthat:

increased agricultural surplus,

Increased the productivity of urbanworkers, and

Increased the efficiency of exchange

and transportation.


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Locational Equilibrium is achieved when given the prices ofdifferent locations every one is satisfied with his location, i.e.no incentive to move.

Prices adjust so people are indifferent between desirable andundesirable locations.

Examples of prices behind locational equilibrium

Rent on beach house > Rent on highway house

Land rent in center > Land rent on fringe

Axiom 1: Prices Adjust to Achieve LocationalEquilibrium


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A change in something leading to additionalchanges in the same direction.

Example: Concentration of automobile sellersin a certain area makes the area moreattractive for other automobile sellers tolocate, resulting in more concentration.

Cluster of artists attracts other artists

Axiom 2: Self-Reinforcing Effects GenerateExtreme Outcomes


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When benefits or costs of a transaction fall on athird party, the market outcome is sociallyinefficient.

Externality: cost or benefit of a transactionexperienced by someone else

External cost: burning gasoline affects breathers

External benefit: painting a peeling house increasesproperty values

Axiom 3: Externalities Cause Inefficiency


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Economies of scale occur when doubling all inputs ofproduction results in more than doubling output.

Economies of scale: Average cost decreases as quantity

increases

Indivisible inputs: Required to produce one or a thousand units

Factor specialization: Benefits from continuity and repetition

Extent of scale economies varies across activities

Axiom 4: Production is Subject to Economiesof Scale


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worker Number of machines

5 10 15 20 25 30 35 40

0 0 0 0 0 0 0 0 0

1 30 100 250 340 410 400 400 390

2 60 250 360 450 520 530 520 500

3 100 360 480 570 610 620 620 6104 130 440 580 640 690 700 700 690

5 130 500 650 710 760 770 780 770

6 110 540 700 760 800 820 830 840

7 100 550 720 790 820 850 870 890

8 80 540 680 800 830 860 880 900

x om : ompe on enera es ero


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In the absence of barriers to entry, we expect firms to enter amarket 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

Economic cost includes explicit cost and opportunity cost oftime and funds

Firms earn just enough to stay in business, but not enough toattract entrants

x om : ompe on enera es eroEconomic Profit


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EXAMPLE

Adam decided to open a bakery. Hecould earn $50,000/ year in another job.He withdraws his savings from the bank,

$100 000 , which was earning 7%. Themarket for baked goods is a perfectcompetitive market

After paying all his expenses how muchmoney do you expect Adam to bemaking in a year?

Week 3 Lesson2

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