6Chapter 1Introduction and Axioms of Urban EconomicsTABLE1-2 Populations and Projected Populations of Large World CitiesPopulation 1975Population2005Population2015Percent ChangeNationMetropolitan Area(million)(million)(million)2005-201526.635.5TokyoJapan35.211110.719.421.6Ciudad de MexicoMexico(Mexico City)Brazil9.618.320.512Sao Paulo20Mumbai (Bombay)India7.118.221.924DelhiIndia4.415.018.67.319ShanghaiChina14.517.27.919India14.317.0Kolkata (Calcutta)4.813.227JakartaIndonesia16.8Buenos Aires8.712.613.47Argentina2.212.435DhakaBangladesh16.84.011.631KarachiPakistan15.27.611Rio de JaneiroBrazil11.512.809.811.311.3Osaka-KobeJapan6.411.113.118Al-Qahirah (Cairo)Egypt1.948Nigeria10.916.1Lagos6.010.712.920BeijingChina5.010.712.921ManilaPhilippines31.610.711.0Moskva (Moscow)RussianFederation058.69.89.9ParisFrance3.69.711.2IstanbulTurkeySource: United Nations, Urban Agglomerations 2005.Figure 1-3(page 7) shows the time trend of large urban agglomerations inthe world, defined as metropolitan areas with at least I million people. The figuredistinguishes between cities in the developed and less developed regions.In 1970,thetwotypesof regions had roughly the same numberof large cities.By1996,however, the number of large cities in the less developed regions nearly doubled,and by 2015 there will be roughly four times as many large cities in less developedregions.THEFIVEAXIOMSOFURBANECONOMICSUrban economics explores the location choices of households and firms,and so it isnaturaltoassumethatpeopleandfirms aremobile.Ofcourse,peopledon'tinstantlychange their workplaces and residences when circumstances change; therefore, amodel of perfect mobility tells us more about long-term changes than short-termones.Theaveragehousehold changes itsresidenceevery seven years,meaning thatabout14percentofthepopulationmoveseveryyear.Althoughmostmodelsofurban economics assume perfect mobility,there are exceptions,and we will high-light the analysis that assumes less than perfectmobility.In this part of the chapter, we introduce five axioms of urban economics. Anaxiom is a self-evident truth, something that most people readily understand and ac-cept.Forourpurposes,"mostpeople"arepeoplewhohavetakenatleastonecourseineconomicsThefiveaxioms lieattheheartofurbaneconomicsandtogetherpro-vide a foundation for the economic models of location choices.As you go throughthebook,thesefiveaxiomswillappearrepeatedly1.PricesAdjusttoAchieveLocationalEquilibriumA locational equilibrium occurs when no one has an incentive to move. SupposethatyouandBud arecompetingfortwo rental houses,onealongabeautiful beachand one along a noisy highway.If the two houses have the same price (the samemonthly rent),you would prefer the beach house, and so would Bud.Flipping a coin-
Chapter1IntroductionandAxiomsofUrbanEconomics7FIGURE1-3TheNumber of LargeAgglomerationsin theWorld,1950-2015600500oendainn40030020010019501970199620154983115More developed regions1298244Less.developedregions221527Source:United Nations World Population Prospects (New York: United Nations,2o01)and giving thebeach house to the winner wouldn't generate a locational equilibriumbecausetheunluckypersoninthehighwayhousewouldhaveanincentivetomovetothemoredesirablehouseLocationalequilibriumrequiresahigherpriceforthebeachhouse.Toeliminatethe incentiveto move,the price of the beach housemust be high enough tofullycompensate for the better environment.The question is,Howmuch money are youwilling to sacrifice to live on thebeach?If your answer is $300and Bud agrees,thenthe equilibrium price of the beach house will be $300 higher than the price of thehighwayhouse.Ingeneral.prices adjusttogeneratethe sameutilitylevel in differentenvironments,gettingpeopleto live inbothdesirableand undesirable locationsThe samesortof economicforcesoperateinthelabormarket.Workers com-pete for jobs in desirable locations, causing lower wages in more desirable loca-tions.Suppose you are competing withRickifortwo jobs,one in Dullsville andonein Coolsville,a city with a more stimulating social environment.If a $500 gap inthemonthlywagefullycompensatesforthedifferenceinthe social environmentthe equilibrium wage will be s50o lower in Coolsville.The two workers will beindifferentbetweenthetwocitiesbecauseamovetoCoolsvillemeansa$5o0wagecut. In the labor market, wages adjust to get people to work in both desirable andundesirableenvironments.Thepriceof land alsoadjuststoensurelocational equilibrium amongfirms.Office firms competefor themost accessible land in a city,and land atthe centeristhemostaccessibleandthusthemostexpensive.In equilibrium,officefirms onlessaccessiblelandfarfromthecenterpaylowerpricesforland,andcanbejustas
8Chapter 1Introduction and Axioms of Urban Economicsprofitableasfirmsonthemostaccessibleland.2.Self-ReinforcingEffectsGenerateExtremeOutcomesA self-reinforcing effect is a change in something that leads to additional changesin the same direction.Considera city where the sellers of new automobiles are ini-tiallyspread evenlythroughoutthecity.If onesellerrelocatesnexttoanotherselleronAutoRoad,whathappensnext?Autoconsumerscomparebrandsbeforebuying,and thepair of sellers on Auto Road will facilitate comparison shopping and thusattract buyers.The increased consumer traffic on Auto Road will make it an attrac-tive sitefor other auto sellers,sothey will movetoo.Theultimateresult is anautorow,"acluster offirmsthat competeagainstoneanother,yet locatenearbySelf-reinforcing changes also happen in the location decisions of people.Sup-pose artists and creative types are initially spread out evenly across a dozen citiesin a region,If by chance one city experiences an influx of artists, its creative envi-ronmentwill improveas artists (1)are exposed tomore ideas and fabricationtech-niquesand(2)can share studios,printshops,tool suppliers,and otherfacilities.Thecluster of artists will attract other artists from the region,causing a concentration ofartistic production in one city.In recent decades,cities that have attracted artists andcreative folks have experienced relatively rapid growth (Florida, 2002).3.ExternalitiesCauseInefficiencyIn mosttransactions,the costs and benefits of the exchange are confined to theindividual buyer and seller. The consumer pays a price equal to the full cost ofproducingthe good,so no one elsebearsa cost from the transaction.Similarly,theconsumer is the only person to benefit from the product. In contrast, an external-ityoccurswhensomeofthecostsorbenefitsofatransactionareexperiencedbysomeone otherthanthe buyer or seller,thatis,someone externalto thetransactionAnexternal costoccurswhenaconsumerpaysapricethatislessthanthefullcost of producing a product.The price of a product always includes the costs of thelabor,capital,and rawmaterials usedto producetheproduct,butitusuallydoes notinclude theenvironmental costs of producing theproduct.For example,ifburninggasoline in automobiles generates airpollution,partof the cost of driving is bornebypeople whobreathe dirtyair.Similarly,whenyou enteracrowded highway,youslow down everyone else, meaning that other drivers bear a cost.Anexternal benefitoccurswhenaproductpurchasedbyonepersongeneratesabenefitfor someone else.Forexample,paintingmypeelinghouseimproves theappearance of my neighborhood, increasing the value ofmy neighbor's house as wellas mine.Education generates external benefits because it improves communicationand thinking skills,making a person a better team worker.In other words, some ofthe benefits ofeducation areexperienced by a person'sfellowworkers,who becomemoreproductiveand thusearn higherwagesWhen there are external costsorbenefits,wedonot expectthemarketequi-libriumtobesociallyefficient.In thecaseof extermal cost,peoplepaylessthanthefull social cost of an action like driving,so they drive too much, In the case ofexternal benefit,peopleget less than thefull social benefitfrom an action likeedu-cation,sothey stop shortof the socially efficient level of education.As we'll seelaterinthebook,citieshaveall sorts of external costsand benefits.Inmanycasesthereisa simplesolution:Internalizetheexternalitywitha tax or a subsidy,and let
9ChapterIIntroductionandAxioms of Urban Economicsindividuals,whothenbearthefull social costandbenefitsof their actions,decidewhat to do.4.ProductionIsSubjecttoEconomiesofScaleEconomies of scale occur when the averagecostof productiondecreases as outputincreases.For most products, if we start with a relatively small production opera-tion and double all inputs,the average cost of production decreases.In the jargon ofeconomics,whenthelong-runaveragecostcurveisnegativelysloped,wesaythatthere are scale economies in production.Scale economies occurfor two reasons:Indivisible inputs.Some capital inputs are“lumpy"and cannot be scaled.down for small operations.As a result, a small operation has the same indivis-ibleinputsasalargeoperation.Forexample,tomanufacturefrisbeesyouneeda mold, whetheryou produce one frisbee perday or a thousand.Similarly,toproduce microprocessors you need a clean room and other expensive equip-ment,whetheryouproduce one processor per day or a thousand.As outputincreases,the average costdecreases because the cost of the indivisible input isspread over more output.Factor specialization.In a small one-person production operation,a worker.performs a wide variety of production tasks. In a larger operation with moreworkers,each worker specializes in afew tasks,leading to higher productivitybecauseofcontinuity(lesstimeisspentswitchingfromonetasktoanother)andproficiency(fromexperienceandlearning).Thenotionoffactorspecializationis captured in the old expression,"A jack of all trades is master of none."Addingto thisexpression,wecan saythata specialized workeris amaster of onetask.As we'll seelater in the book,scale economies play a vital role in urban econo-mies.In fact,as we'll see in Chapter 2, if there areno scale economies,there will beno cities.It is costlyto transport productsfrom a production siteto consumers,socentralized production incities will be sensible only if thereis some advantagethatmorethanoffsetstransportcosts.The extent of scaleeconomies in production varies across products.Micropro-cessors are produced in $5 billion fabrication facilities with a highly specializedworkforce performing hundreds of complex tasks,resulting in large scale eco-nomiesinproduction.Incontrast,pizzaisproducedwitha$5,oo0pizzaoven withjustafewproductiontasks,soscaleeconomiesareexhaustedsooner.Ingeneral,theextent of scale economies is determined by the lumpiness of indivisible inputs andtheopportunitiesforfactorspecialization.5.CompetitionGeneratesZeroEconomicProfitWhen therearenorestrictions on theentryoffirms into a market,we expectfirmstoenterthemarketuntileconomicprofit is zero.Recall thateconomicprofitequalstheexcessoftotal revenueovertotaleconomiccost,whereeconomiccost includestheopportunitycosts of all inputs.Twokeycomponentsofeconomiccosts aretheop-portunity cost of the entrepreneur's time and the opportunity cost offunds investedinthefirm.Forexample,supposeanentrepreneurcouldearn$60,o00inanotherjob and invests s100,o00in the firm,takingthemoney out of a mutual fund thatearns8percent.Theeconomiccostof thefirmincludes$60,oo0intimecostand
10Chapter1 Introduction and Axiomsof Urban Economics$8,o00 in investment cost.Once we accountforall the opportunity costs,thefactthateconomicprofitiszeromeansthatafirmismakingenoughmoneyto stayinbusiness,butnotenoughfor otherfirmsto enterthemarket.Earningzeroeconomicprofitmeansearning"normal"accountingprofit.In urban cconomics, competition has a spatial dimension.Eachfirm enters themarket at some location,and the profit of each firm is affected bythe locations ofotherfirms.Spatial competitionlooksalotlikemonopolisticcompetition,amarketstructure in which firms sell slightly differentiated products in an environment ofunrestricted entry.Although this sounds like an oxymoron such as"tight slacks"andjumboshrimp,"thewordsarerevealing.Eachfirmhasa monopolyforits dif-ferentiated product,but unrestricted entry leads tokeen competitionfor consumerswhocaneasily switchfromonedifferentiatedproductto another.Withspatialcom-petition, each firm has a local monopoly in the area immediately surrounding itsestablishment,but unrestrictedentryleadstokeencompetition.Firmswill continuetoenterthemarketuntileconomicprofitdropstozero.WHAT'SNEXT?This introductory chapter sets the stagefor the economic analysis of cities in therestof thebook.Here are someof thebig questions we'll address in coming chapters.Why do cities exist?Arecitiestoobigortoosmall?.Whatcauses urban economic growth?Why is employment in modern cities so widely dispersed?·Why is there somuch segregation with respect to race and income?..Whydo economists advocate a tax of about 7 cents per milefor all driving andabout 27 cents permilefor driving on congested roads?Whydo sofewpeopletakemass transit?·What are the key inputs in the education production function?.Why is crime higher in cities?.Why does the typical metropolitan area have dozens of municipalities?In answering these and other questions, we will use the five axioms of urbaneconomics.Inaddition,wewill useanumberof economicmodelsto explorethespatial aspects of decisionmaking.It's worth noting that much of the analysis inthe book reflects advances in urbaneconomics in the last 10 to 15 years,in boththeoreticalmodelingandempiricalanalysis.REFERENCESANDADDITIONALREADING1.Audretsch,David, and Maryann Feldman,"Knowledge Spillovers and theGeography of Innovation,Chapter 61 in Handbook of Regional and UrbanEconomics 4:Citiesand Geography,eds.Vernon Henderson andJacques-Francois Thisse.Amsterdam:Elsevier,2004.2.Bartlett,Randall.TheCrisis ofAmerican Cities.Armonk,NY:Sharp,1998.3.U.S.Government."Standards forDefining Metropolitan and Micropolitan Sta-tistical Areas."Federal Register 65, no.249 (December 17,2000).4.Florida,Richard.TheRise of theCreative Class.NewYork:Basic Books,2002