What is Urban Economics-WEEK 4-LOURDES

7/28/2019 What is Urban Economics-WEEK 4-LOURDES

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What is Urban Economics

Distance between different economics activitiesimplies costs for transporting goods and movingpeople. Distance also defines communication and

social interactions among consumers andworkers.

Historically, much of urban economic analysisrelies on a particular model of urban spatial

structure, the monocentric city model pioneeredin the 1960s by William Alonso, Richard Muth,and Edwin Mills.


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Axioms of Urban Economics

The five axioms of urban economics are

essential to understanding how urban

economics works and how it is applied. An

axiom is a self-evident truth. This means thateach of these five things is something that

most people can understand and accept to be

true. These five axioms provide the basis forurban economics and the foundations for all

topics associated with urban economics


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Axiom 1: Prices Adjust to Achieve

Locational Equilibrium

If the price were the same for two houses, one thatwas in Hawaii on the beautiful beach and the otherlocated in a slum in New York City, there would be anincentive for one to move to the house in Hawaii. A

locational equilibrium occurs when there is noincentive to move. In order to achieve this, the price ofthe slum house will decrease as the price of the beachhouse in Hawaii increases. That way, a person whocould afford either house before now has either an

incentive to move to the cheaper house they can affordrather than the nice beach house which a moreaffluent person can now live in.


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Axiom 1: Prices Adjust to Achieve LocationalEquilibrium

In a locational equilibrium amenities of a

location are capitalized in the rental rate: Rent on beach house > Rent on highway house

or Land rent in center > Land rent on fringe

Amenities for a location may also becapitalized in wages:

Wage in Klang Valley > Wage in Senawang


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Axiom 2: Self-Reinforcing Effects

Generate Extreme Outcomes This axiom means that if one type of person moves into an area,

then that area will become more attractive to more of the sametypes of people. For instance, a few artists may move into a cityand because of their artistic touches to the city and local night lifemore and more artists will move in until it is a complete artistic city

that will draw even more artists to the area. Another example of aself-reinforcing effect generating extreme outcomes is if one or twocar dealerships were to locate in the same area. People would thenwant to shop for cars in this area thus making it even moredesirable for auto stores and car dealerships to locate here. Thiswould then create an extreme outcome of an auto cluster. This can

happen with almost any type of neighborhood and this is why it iscommon to see a lot of the same types of things or people groupedtogether in a city


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Axiom 2: Self-Reinforcing Effects Generate

Extreme Outcomes: Self-reinforcing effects

lead to changes in same direction. For

example, auto row attracts comparisonshoppers. A cluster of artists attracts other

artists


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Axiom 3: Externalities Cause

Inefficiency An external cost is one in which the full extent of an action is not

paid by the person performing the action. It will affect otherpeople as well. For instance, if you drive on the highway it will slowdown everyone else who is also on the highway. Also, in the case ofrubbernecking, which is slowing down to see an accident on the

side of the road, your curiosity will slow down everyone else on thehighway. An external benefit is one in which something that oneperson does creates a benefit for someone else. This is mostcommon in neighborhoods where one person may makeimprovements to their property thus helping their neighborsincrease their property value because the area will suddenly

become more desirable. When there are costs and benefits insociety the market is not socially efficient.


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Axiom 3: Externalities Cause Inefficiency : A

externality is a cost or benefit of a transaction

experienced by someone other than the buyer

or seller. Examples: External cost burninggasoline affects breathers of the air. External

benefit painting a peeling house increases

values of neighboring properties.


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Axiom 4: Production is Subject to

Economies of Scale

In order to achieve economies of scale theaverage cost of production has to decrease asoutput increases. The two things that

contribute to economies of scale areindivisible inputs and factorspecialization. These are important herebecause inputs can be spread farther as

output increases and people can work in morespecialized areas thus allowing them tobecome more efficient at what they do


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Axiom 4: Production is Subject to Economies ofScale: Economies of scale describes how averagecost decreases as the output quantity increases.

There are several explainations for thisphenomenon: Indivisible inputs: required toproduce one or a thousand units. Factorspecialization : Jack of all trades master of none.

Specialized worker is a master of one task.Repetition and learning. Extent of scaleeconomies varies across activities


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Axiom 5: Competition Generates Zero

Economic Profit

This states that firms will continue entering

the market in the same location until

economic profit becomes zero. Once this is

reached, a firm will be making enough moneyto continue their business, however there will

not be an incentive for new firms to continue

entering the market


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Axiom 5: Competition Generates Zero

Economic Profit : Entry into market continues

until economic profit is zero. Economic cost

includes all opportunity cost, includingopportunity cost of time and funds. Zero

economic profit: Firms making just enough

money to stay in business; not enough toattract more entrants


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Why Do Firms Cluster?

The standard neoclassical models in Urban

Economics, e.g.

Muth-Mills and von Thnen, assume that

there is a central business

district in which all firms locate. This is taken

as an exogenous assumption outcome.


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Why do competing firms locate close to one

another?

Two explanations:

1 Localization economies: firms in an industry

cluster

2 Urbanization economies: firms in different

industries cluster


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There are many significant reasons why firmswould choose to cluster together in acity. The economic forces which cause this

clustering are called agglomerationeconomies. Localization economies are whenfirms locate within one singleindustry. Urbanization economies are when

firms locate across industry boundaries. Onefirm may have an incentive to move closer toanother firm eventually creating a dense city


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Sharing Intermediate Inputs

Firms may locate close to one another in an effort toshare intermediate inputs. This is important withindustries or firms that have similar inputs and can

benefit from being close to one another. By sharingintermediate inputs they should be able to cutproduction costs and increase specialization thusmaking production subject to economies ofscale. Many high-tech products are made up of smaller

components which make it useful for firms to locatewhere these smaller components are beingmanufactured.


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Sharing a Labor Pool

Firms are able to share workers when locating closetogether. This helps people to find what they are goodat and for firms to hire productive people for their

particular production item while a person may bebetter suited for working with a different firm. Thisalso ties into the idea of labor matching. A firm canlose a lot of money training workers who do not havethe necessary skills for their job, but in a big city, they

have a larger area of workers to choose from and thusbetter matches between workers and employers canbe produced


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Knowledge Spillovers

This is helpful in causing firms to cluster as they cangain from one another's knowledge and hopefullyeducated workers. From examining thesedifferent concepts, it seems that firms can benefitgreatly from locating in a cluster. They can shareinputs and a labor pool, provide better skillsmatching among workers, and generate

knowledge spillovers. All of these thingscontribute to lower production costs which inturn will increase profit for the firms


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Joint Labor Supply

Firms have an advantage to clustering when taking intoaccount joint labor supply. This refers to married coupleswho often seek places to live based on what jobs areavailable. This means that different types of firmsclustering together will attract those couples who have toconsider each individual finding a job. Having differentfirms in one area is beneficial to both the workers and thefirm. Often, those who are married and both parties areworking tend to have a higher level of education thus

adding to the labor pool from which the firms canchoose. These firms clustering lead to the development ofa larger urban area to which couples interested in jointlabor supply will be attracted.


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Sources of localization economies

Some alternative explainations for firm

clustering include:

I Sharing Intermediate Inputs

II Sharing a Labor Pool

III Labor Matching IV Knowledge Spillovers


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II. Sharing Intermediate Inputs

A Intermediate inputs: one firms output provides inputs forother firms

B Historical example: dresses and buttons

a Firms producing high fashion dresses must be small

b Scale economies exist in producing buttons are largerelative to the demand associated with a single dressmaker

c Face time is requires to design and fabricate buttons tofit dresses

d Variety is required in types of buttons demanded (shape,finish, color


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Key Points in the Economic Logic

a Higher total demand for buttons allow the buttonmaker to realize economies of scale

b Button makers can specialize in types of buttons,

reducing modification costs High-Technology Firms

1 Rapidly changing products necessitates intermediateinputs

2 Face time is required for the design and fabrication ofintermediate inputs

3 Firms share suppliers of intermediate inputs


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Sharing Pool Labour

The Isolated Firm

1 Perfectly inelastic supply of labor to firm:only employer in town

2 Variation in demand generates variation in

wages


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Equilibrium with Clustered firms

1 Perfectly elastic supply of labor to individualfirm

a Each firm is one of many b Constant total demand for labor implies

constant wage (lower risk)

2 Locational equilibrium for workers: same

expected wage in cluster and isolated site = $10 3 Variation in product and labor demand

generates variation in workers hired, not wage


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Clustering Increases Expected Profit

1 Year of high demand: more profit because of lowerwage and more workers

2 Year of low demand: less profit because of higher

wage 3 Good news dominates bad news: firm responds to

changes in demand

a High demand: hire more workers to exploit relatively

low wage b Low demand: hire fewer workers to cushion blow of

high wage


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Labor Market Matching

The logic goes as follows:

1 Jobs and workers not always perfectly

matched

2 Mismatches require training costs to

eliminate skill gap

3 Larger city provide better matches


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Knowledge Spillovers

Basic logic:

A Firms in an industry share ideas and knowledge

1 mysteries of trade are in the air

2 innovations are promptly discussed, improved, andadopted

B Widespread empirical evidence of knowledge spillovers

1 Spillovers more important in idea industries

2 Most innovative industries are the most likely to cluster 3 Spillovers have range of a few miles


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History in Economic Thought

When an industry has chosen a locality for itself, it is likely to staythere for long; so grate are the advantages which people followingthe same skilled trade get from near neighborhood to one another.The mysteries of the trade become no mysteries; but are as if were

in the aire, and children learn many of them unconsciously. Goodwork is appreciated; inventions and improvements in machinery, in

processes and the gneeral organization f the business have theirmerits promptly discussed; if one man starts a new idea, it is takenup by others and combined with suggestions of their own; and thusit becomes the source of new ideas.

Alfred Marshall, 1920


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Self-Reinforcing Effects Cause Industry Clusters

1 When firms cluster, they may lose exclusive marketareas

2 Clustered firms however share a larger market area

3 Clustering may increase average transport costs

4 But, these costs increases must be balanced withlocalization economies: shared inputs, labor market

pooling and skill matches, and knowledge spillovers 5 Self-Reinforcing Effects Generates an Extreme

Outcome


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Vertical axis measures profit

gap (firm in center vs. isolated

firm)

2 Single firm in center : profit gap is zero

3 Second firm in center cuts button costs and

increases profit per firm by $6 4 If third firm joins cluster, profit gap increases

to $13


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Evidence of Localization Economies

1 Worker productivity is higher in clusters

2 More firm births in clusters

3 Employment growth is more rapid in clusters

Why Cities Exist and How They Have


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Formed

In order to understand why cities exist we

must first consider a world without cities. For

there to be a place with no cities there must

be equal productivity, constant returns toscale in production, and constant returns to

scale in exchange. Equal productivity allows

each person to be responsible for his or herself and there is no specialization in any one

area thus there is no need for a city to develop



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Formed

The next thing necessary for there to be no

cities is for there to be constant returns to

scale in production. So if production is subject

to economies of scale, then households will bemore likely to involve a trading firm when

trading their products. This is because trading

firms will have the ability to effectively tradewith lower transaction costs than if the

household were to do it themselves



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Formed

The last necessary condition for cities to not

exist is constant returns to scale in

exchange. If there are scale economies in

exchange then two households will linktogether and exchange the products in which

they have a comparative advantage.

http://www.econport.org/content/handbook/productionpossibilities/Comparative-Advantage.htmlhttp://www.econport.org/content/handbook/productionpossibilities/Comparative-Advantage.htmlhttp://www.econport.org/content/handbook/productionpossibilities/Comparative-Advantage.html


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Formed

Once all three of these conditions are changed, atrading city will emerge. Different firms locate indifferent areas based on what type of transport coststhey have. Most firms will choose to locate in a trading

city because the benefits outweigh the costs. In atrading city a firm has access to a large customer base,good access to foreign markets, and a large laborpool. This outweighs the fact that in a city there are

higher rents and the firms must pay their workershigher wages. There are two different types oftransaction costs that affect where a firm will locate


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Some firms have inputs that are cheaper to transportin the beginning than at the end and this is calledmaterial-oriented. When they focus on outputs this iscalled market-oriented and the companies will locate

where the final product will be Lets take away equal productivity first and see where

that leaves us. If there are two regions that are notequally productive then it can be assumed that one

area may be better in producing one or more productsthan the other region. This is called comparativeadvantage
http://www.econport.org/content/handbook/productionpossibilities/Comparative-Advantage.htmlhttp://www.econport.org/content/handbook/productionpossibilities/Comparative-Advantage.htmlhttp://www.econport.org/content/handbook/productionpossibilities/Comparative-Advantage.htmlhttp://www.econport.org/content/handbook/productionpossibilities/Comparative-Advantage.html


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If one region has a comparative advantage

then it is more beneficial to produce that item

and trade for another item that another

region may have a comparative advantage inproducing. To learn more about comparative

advantage and trade visit the production

possibilities section.
http://www.econport.org/content/handbook/productionpossibilities.htmlhttp://www.econport.org/content/handbook/productionpossibilities.htmlhttp://www.econport.org/content/handbook/productionpossibilities.htmlhttp://www.econport.org/content/handbook/productionpossibilities.html


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Considering constant returns to scale in productiononce more we can assume that production is subject toeconomies of scale. So, if a household were tospecialize in one specific thing, then the inputs wouldbe indivisible such as machines and workers couldspecialize in certain tasks thus leading to a higherproductivity and lower costs all around.

The last condition for there to be no cities is to haveconstant returns to scale in exchange. Households can

link together and directly trade, however witheconomies of scale in exchange trading firms willemerge because they ultimately have lower transactioncosts.



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Formed

Therefore, it can be seen that cities existbecause it is beneficial to produce what youare good at and use trading firms to lower

costs and trade with other cities that mayspecialize in something else. Because of thistrading effect and the fact the firms cluster,larger cities will develop with a central

business district.http://www.econport.org/content/handbook/Urbanecon/exist.html

A i 4 P d i i S bj
http://www.econport.org/content/handbook/Urbanecon/firmscluster.htmlhttp://www.econport.org/content/handbook/Urbanecon/firmscluster.html


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Economies of Scale

Why do cities exist?

Cities are places in which population density isgreater than the other parts of the countries.

In an economic context, what are the factorsbehind the creation of the cities?

Lets build up a model

Assumptions:

1. The region produces and consumes two goods:shirts and bread.

A i 4 P d i i S bj


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Economies of Scale

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. Residentswalk at a speed of8 miles per hour.

A i 4 P d i i S bj


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Economies of Scale

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 andshirts, there is no advantage of trading.

A i 4 P d ti i S bj t t


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Economies of Scale

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. Lets say that the region has two parts: South

and North. The production amounts in each

region are given below:



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Economies of ScaleOUTPUT PERHR

(OF A WORKER)

OPPORTUNITY

COSTS

SOUTH NORTH SOUTH NORTH

BREAD 2 2 1shirt 3shirt

SHIRTS 2 6 1bread 1/3bread



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Economies of Scale South has a comparative advantage in production of

bread.

North has a comparative advantage in production ofshirts.

2. Suppose that there are no scale economies intransportation. Transport cost per unit of shipped permile is independent of the volume shipped.

But, if transport cost per mile decreases as the volumetransported increases, it would be cheaper to

transport shirts and bread in bulks. This also createsintermediaries in transportation.

What are the implications?



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Economies of ScaleThe trading firms will locate at places convenient for the collection and distribution of

goods. Hence, marketplaces develop at crossroads, ports and other shipmentpoints.

The location decisions of the trading firms cause the development ofcities. Themarketplace 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 restof the region.


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Economies of Scale

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: Thereare 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?

A iom 4 Prod ction is S bject to


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Economies of Scale

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, costsdecline with output).

Axiom 4 Production is Subject to


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Economies of Scale

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 increasesfactory uses more indivisible inputs hence

productivity increases.



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Economies of Scale

If the shirt factory produces 400 units with 100 workers and 4shirts 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 workersindifferent between working in the factory and working athome.

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

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

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



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Economies of Scale

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

Net price of a factory shirt:

Price paid by consumer to firm (0.25 loaf)

+

Consumers opportunity cost of the time spent traveling

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

producing bread).



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Economies of Scale

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

Since, production cost is equal to 0.25 loaf, the

consumer should consider the time that a triptakes.

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 afactory shirt.



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Economies of Scale

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



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Economies of Scale 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 homeand factory meaning they they themselves incur freight costs. This costof transporting goods limits the ability of the factory to exploiteconomies 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 methodto 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), marketarea will be a circle with a radius of 6 miles. This will increase the outputof the factory, factorys workforce and population of the factory city.



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Economies of Scale

Decrease in freight cost allows factory to morefully exploit economies of scale, increasing citysize.

Transportation is a very important factor affecting

the city size2. Scale economies: As economies of scale

beacome more powerful, cost of factoryproduction decreases relative to home

production.Hence, market area of the factory increases andsize of factory cities increase.


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Commuting costs: Larger cities have largescommuting 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 tothe net price of the factory shirts, increase inwages is a limit to the city size

Why Firms Cluster


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Why Firms Cluster

Causes of


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Causes of

Urban Expansion

1

An increase in population will increase urban expansion.

2.

An increase in household income will increase urban expansion.

3.

An increase in transportation costs will reduce urban expansion.

4.

An increase in the opportunity cost of non-urban land will reduce urbanexpansion.

Causes of


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Causes of

Urban Expansion

5.

An increase in the marginal productivity of land in housing production will causeurban expansion.

6.

An increase in the share of land available for housing development will increaseurban extent and urban expansion.

7.

An increase in marginal productivity of land in production of the export good willincrease URBAN expansion.

8.

An increase in the world price of the export good will increase urban expansion.

What is Urban Economics-WEEK 4-LOURDES

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