Urban Economics test #1

Econ 322
STUDY
PLAY
First Axiom of Urban Economics
Prices adjust to achieve locational equilibrium
Second Axiom of Urban Economics
Self-reinforcing effects generate extreme outcomes
Third Axiom of Urban Economics
Externalities cause inefficiency
Fourth Axiom of Urban Economics
Production is subject to economies of scale
Fifth Axiom of Urban Economics
Competition generates zero economic profit
Backyard production model
1. No differences in productivity for labor or land
2. Constant returns to scale in exchange
3. Constant returns to scale in production
Implications of the backyard production model
1. No trade
2. No cities
Trading Cities
Differences in productivity generate comparative advantage
Computing Net Gain from Trade
Net gain = gross gain - transaction time (t)
Factory Town
Develop around factories to economize on commuting time.
Competition for land bids prices up.
High price of land increases density, which creates a city.
Factory workers must be paid to cover higher cost of living.
Factory Towns in the Region
Firms will enter until each make zero economic profit.
Factories span the region
Land Rent in the Region
Axiom 1.
Locational indifference in rural areas. Lower travel cost but higher land price close to cities.
Locational indifference
Lower travel cost but higher land price close to cities.
Factory wage compensates for higher land prices in cities causing rural and urban indifference
Market Orientation
More costly to transport output than input.
Four Types of Market Oriented firms
1. Weight gaining activity
2. Fragility gaining
3. Bulk gaining
4. Hazard gaining
Material Orientation
More cost to transport inputs than outputs
Three Types of Material Oriented Firms
1. Weight losing
2. Fragility losing
3. Hazard losing
System of Towns
Scale economies in processing, the number of plants is relatively small. Entry and competition generates zero profit.
Examples of Material Oriented Firms
Steel towns: near coal, then ore.
Leather towns: near forests for tannin
Lumber towns: near forests
Industrial Revolution
Innovations:
Manufacturing
Transportation
Agriculture
Energy technology and location decisions
Location decision for Material Oriented firms
Firm will choose to locate near the material source because it is cheaper to produce the product at the source and then transport to the city.
Principle of Median Location
The median location splits travel destinations into two equal halves, with half the destinations in one direction and half in the other direction.
Pizza Illustration:
1. All inputs (labor, dough, toppings) are ubiquitous (available at all locations for the same price), so input transport costs are zero.
2. The price of pizza is fixed, and each consumer along the highway demands one pizza per day.
3. Ann bears the delivery costs of $1 per mile traveled. Each pizza requires a separate trip.
Total delivery cost will be minimized at the median location, defined as the location that splits travel destinations into two equal halves.
Innovation Cities
No scale economies in production or exchange (ruling out trading or factory cities).
Alternative to self sufficiency is innovation - generating ideas to sell to others.
Innovation facilitated by collaboration, which is enhanced by education.
Facilitate knowledge spillovers and are centers of innovation.
Innovation increases with the education level of a city's workforce
Firms Cluster
1. Share intermediate inputs
2. Share a labor pool
3. Get better matches of workers and labor tasks
4. Share knowledge
Localization Economies
Firms in an industry cluster
Urbanization Economies
Firms in different industries cluster.
Results in large diverse cities.
Sharing, pooling, matching
Agglomeration Economies
Localization economies + Urbanization economies
Clustering to Share Intermediate Inputs
Firms share inputs, and cluster to facilitate face time.
Example: Fashion House on 7th Avenue NYC
Rapid changes in fashion and output: firms are small & nimble
Scale economies in inputs large relative to demand of single firm
Face time require to design and fabricate buttons to fit dresses
We know that the fashion industry benefits from clustering but why is it that large clothing retailers produce in dispersed locations.
High-Technology Firms
Rapidly changing products necessitates intermediate inputs
-Electronic components
-Testing facilities
Scale economies in intermediate input.
Value of face time in design and fabrication.
Self-Reinforcing Effects of Clustering
Tradeoffs
-Benefit: localization economies reduce cost of intermediate input
-Cost: competition for workers increases labor cost
Clustering to Share a Labor Pool
In an isolated site, wage is variable and workforce size (pool) is fixed because Ls is inelastic.
In a cluster, wage is fixed and workforce size is variable because Ls in perfectly elastic.
Varying demand for each firm.
Fixed industry-wide demand.
Locational Equilibrium in a Wage Cluster
Wage in a cluster = expected wage in isolated site
Computing Profits
Labor demand: marginal benefit = revenue contribution = MRP.
Profit from an individual worker = MRP - wage.
Profit from workforce: Triangle between demand curve and wage line.
Move to Cluster Increases Expected Profit
High demand (good news): more profit in cluster because of lower wage and more workers.
Low demand (bad news): less profit in cluster because of higher wage.
Good news dominates bad because firms respond to changes in demand.
High demand in a cluster
Hire more workers to exploit lower wage in cluster
Low demand in a cluster
Hire fewer workers to cushion blow of higher wage in cluster.
Clustering to Facilitate Labor Matches
-Firms and workers not always perfectly matched.
-Mismatches require training costs to eliminate skill gap.
-Show that larger city generates better matches.
Labor Matching Models
1.Helsey and Strange (1990)
-Each firm enters market to produce a product, with a unique skill requirement
-Workers incur training cost to close gap
2. Monopolistic competition: Zero economic profit; wage = Marginal Revenue Product of Labor (MRP)
-Competition: unrestricted entry generates zero economic profit
-Firms are differentiated with respect to skill requirement
-Firms offer wage and workers accept highest net wage
Clustering to Share Knowledge
-Firms in an industry share ideas and knowledge.
-Mysteries of trade are "in the air"
-Innovations are promptly discussed, improved, and adopted.
Evidence of Knowledge Spillovers
-Spillovers more important in idea industries.
-Most innovative industries are the most likely to cluster.
-Spillovers have range of a few miles.
Evidence of Localization
-Worker productivity
-Firm births
-Growth in industry employment
-Growth more rapid close to existing concentration.
-Rapid growth close to locations with existing jobs.
Urbanization Economies and Knowledge Spillovers
-Diverse city is fertile ground for new ideas
-Bulk of patents issued to people in large cities
-Disproportionate number of patent citations from same city.
-Evidence of Urbanization Economies
Benefits of Urban Size
-Joint labor supply (better employment opportunities)
-Learning opportunities (permanent increase in wage and learning through imitation)
-Social Opportunities (better matches in large city)
The Von Thunen Model (1826)
In an isolated state under the foregoing assumptions, a patter of rings around the city would develop.
Von Thunen Model Assumptions
1. The city is located centrally within an "isolated state" which is self sufficient
2. The isolated state is surrounded by an unoccupied wilderness
3. The land throughout is completely flat and obstacle-free
4. Soil quality and climate are homogeneous
5. Farmers transport their goods to market via oxcart directly to the central city. Therefore, there are no roads.
6. Farmers act to maximize profits
Von Thunen Model Zones
central city -> intensive farming/dairying -> forest -> extensive field crops -> ranching/animal production
Alonso Bid-Rent Model
Monocentric city with a shopping center as the middle zone that the others develop around.
Alonso Bid-Rent Model Zones
Shopping zone -> Commerical (office zone) -> Residential zone
Sources of Economic Growth
1. Capital deepening: increases in capital per worker
2. Increase in human capital: includes knowledge, skill, experience acquired through education and training.
3. Technological progress: increases in productivity.
4. Geographical perspective: Agglomeration economies- (i) localization (ii) urbanization economies
Urban Utility Curve
The two effects of an increase in city size:
1. increase in wages because of agglomeration economies
2. increase in commuting costs
Shifts in Urban Utility Curve
1. innovation in one city shifts causing the utility of one city to grow and the other to diminish
2. innovation in both cities shifts causing both curves to move
Human Capital
-Increases per-capita income
-Cities with above average share of college grads grow faster
-Workers are more productive
-Wage benefits increase
-Birth of specialized firms (ex: biotechnology)
Urban Employment Growth
Production in an urban economy is sold to locals as well as exported to those living outside the city. Additional export changes the employment multiplier.
Employment multiplier
For every export there is a return in the generation of more jobs or money.
Ex: For every two jobs created at Boise State, another job is created as a result in Ada County giving BSU a multiplier of 1.57
Urban Labor Demand Curve: Negative Slope
-Substitution effect of an increase in the wage
-Output effect of an increase in wage
Shift in the Urban Labor Demand Curve: Negative Slope
-Increase demand for export goods
-Decrease production costs
-Increased productivity
-Decreased tax
-Increased public services
-Land use policies
Urban Labor Demand Curve: Positive Slope
-Simplifying assumptions: fixed hours per worker; fixed participation rate
-Migration in response to wage differences (higher wage attracts more workers)
-Axiom 1: growing cities offer higher wages to offset the higher cost of living
Increase in the labor supply curve
1. Improved amenities such as environmental quality
2. Decreased disseminates such as crime
3. Decreased residential taxes such as property or sales tax
4. Improved residential public services
Percentage change in equilibrium wage
=Percent change in demand / (/Ed/ + /Es/)
/Ed/ = absolute value of the elasticity of demand
/Es/= elasticity of supply
Calculating the percent change of labor
Es * %change in wage
Calculating elasticity of the cost of urban living
%change in cost of living / %change in labor force
Calculating elasticity of the wage of the labor force
%change in wage / %change in the labor force
Calculating elasticity of the labor supply
%change in labor force / %change in wage
Low-tax city
Grows faster, ceteris paribus.
Intracity is between -1.0 and -3.0 (elasticity is larger because firms are more mobile within metropolitan areas than between them)
Intercity is between -0.10 and -0.60
High-service city
Growth is promoted by high tax that supports public services and high tax that supports redistributional programs
Professional Sports Stadiums
Small employment benefits. Money is largely spent by locals, replacing other local spending.
Does have trade benefits for civic/tribal pride and cohesion
Tradeoffs from Environmental Policy
Environmental policy decreases labor demand.
-Increases production cost of polluting good -> decrease output and labor demand.
Improvement in environment increases labor supply.
Net effects on total employment logically indeterminate.
Equilibrium Effects of a Pollution Tax
Increases production costs, decreasing the demand for labor.
Improves environmental quality, increasing the supply of labor.
Pollution Tax and the Distribution of Employment
Both industries (steel and clean) experience lower wages.
Steel: lower wages offset by pollution tax, so decrease employment.
Clean industry: lower wages increase total employment
Problems with employment-multiplier approach
-Horizontal shift of labor demand, not change in equilibrium employment.
-Focuses on jobs rather than income.
-Suggests that face of city in hands of outsiders (export consumers).
Two Models of Trade Among Cities
1. Central Place Theory
2. Gravity Model
Central Place Theory (CPT)
Postulates a hierarchy of cities, in which the larger cities export goods and services to the smaller cities, who in turn export to agricultural areas, who export food to the larger cities. Shows locational patterns.
1. Diversity and scale economies.
2. Large means few.
3. Shopping paths.
Gravity Model
Postulates that intercity trade will depend on the distance between the cities and the relative size of the cities.
CPT Assumptions
1. Population density is uniform.
2. No shopping externalities.
3. Ubiquitous inputs at all locations at the same price.
4. Uniform demand for each product.
5. Number of stores. The goods have different per capita demands and scale economies.
Hierarchy of Cities
Population density is higher in cities that develop around a certain market. The medium and small cities will support fractionally less and have smaller populations than the larger cities.
Zipf's Law
Claims that the number of people in a city is inversely proportional to the city's rank among all cities. In other, the biggest city is about twice the size of the second biggest city, three times the size of the third biggest city, and so forth. Population growth rage of an area is independent of the area's initial population.
Gibrat's Law
Population growth rates are independent of initial population.
Weaknesses of the Gravity Model
1. Consider the case of three equidistant cities, two of which are in one country, while the third is in a second country. It is likely that transaction costs are higher between the first two cities and the theird, but the basic formula does not account for this.
2. The simple gravity model assumes that the only difference among cities is their population. In fact, there are other dimensions of variation that a more sophisticated model might take into account. (Ex: differences in climate, household income, local government tax, and spending behaviors)
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