Urban EconomicsLesson Overview

Urban Economics is the general term for understanding the geographic implications of markets.

In this lesson, we will:

Explain the Creation of Urban Areas

Explain the Location of Urban Areas

Explain Order Between and Within Urban Areas

Explain Land Use and Land Rents

All definitions and source material from:

Urban Economics by Arthur O’Sullivan

Urban EconomicsThe Creation of Urban Areas

What is the Urban Area?

The geographic imprint on the land depicting the pattern and place of human exchanges.

• We say it this way to emphasize that what you see in cities – houses, buildings, roads, parks, restaurants – are the physical expression of a series of market exchanges.

• We say it this way because the patterns of exchange are revealed through the imprint, it tells us something about the scale, health, energy, and proclivities of those within.

• We say it this way because all human actions involve an exchange that can be expressed in economic terms that manifests as a physical space: (e.g. my love is scarce, I measure it out to only one and we build a home together) Likewise, my spiritual life demands a place to express itself publicly, we gather together to build a church together).

Thus, our urban area can be as large as the financial center of central London or as small as the gas station crossroads of Marfa, Texas. The exchanges demanded in the local marketplace drive the urban form.

Urban EconomicsThe Creation of Urban Areas

Economic Factors Contributing to Cities

Historically, some areas have had cities, some have not. What economic factors explain the creation and development of urban areas?

To the extent these vary from big effects to negligible effects over different geographies, urban areas of different sizes form.

Transportation Nodes: the ability to lower transportation costs by locating at ports, hubs and other crossroads reinforces urban concentrations at those locations.

Scale Economies: the ability to lower average unit costs as the volume of production increases creates concentrations of businesses and people.

Comparative Advantages: the differences in natural resources and relative endowments of land, labor, capital and entrepreneurship create geographic variations

in production.

Urban EconomicsThe Creation of Urban Areas

The Country with No Exchange (part 1)

To understand the connect between exchange and urbanization, let’s build a country in which exchanges do not occur:

• Households can grow crops and raise live stock to meet basic needs with abundance using basic household manufacturing techniques like the loom, the shearing of sheep, and the keeping of bees. The necessary inputs are ubiquitous across the landscape.

• Households have identical productive capacity. No one household specializes in any particular skills, or has any special skills, resources or technology to be more productive than another. Their cows get fat at the same pace, they knit replacement socks at the same pace, they knit replacement socks at the same place.

• Household lack effective transportation. Transportation costs are high because everyone only travels by foot.

Continued…..

Urban EconomicsThe Creation of Urban Areas

The Country with No Exchange (part 2)

……continued

• Households lack a technology that would provide an economy of scale. That is, banding together would not allow for two households to increase their production beyond that of two households. There is no synergy in group activity. All endeavors are subject to a constant returns to scale.

• Households never pass on or add kids – husband and wife live childless, happily, forever in blissful hermitage without desire to chat with others beyond their own fence line.

Under these unrealistic assumptions, there is no trade and there are no cities.

Cities must have trade to form, commercial exchange causes cities. Under our assumptions, households evenly distribute over the landscape. As we relax these assumptions, advantages to trade develop and households begin to locate in general proximity to one another.

Urban EconomicsThe Creation of Urban Areas

The Advantage of Trade

In the country with no trade, many of our assumptions described sameness. If we are all the same, there is no purpose to trade. If we are different, there is a purpose to trade. We refer to these as:

Absolute Advantage: The ability to produce more of a given product at the same cost in the same amount of time.

Comparative Advantage: The ability to produce for a lower opportunity cost.

Trade can make both parties better off because both parties can acquire items that would have been too difficult to produce at a reasonable cost.

Urban EconomicsThe Creation of Urban Areas

Comparative Advantage Example

Product Output per Labor Year in Manchester

Opportunity Cost in Manchester

Output per Labor Year in Liverpool

Opportunity Cost in Liverpool

Toothpaste 26,000 1 Toothbrushes 20,000 4 Toothbrushes

OR OR OR

Toothbrush 26,000 1 Tube of Toothpaste 80,000 ¼ Tube of Toothpaste

Who should make toothpaste?

In Manchester, the “price” of one tube of toothpaste is one toothbrush.

In Liverpool, the “price” of one tube of toothpaste is four toothbrushes.

Thus, Manchester has the Comparative Advantage in toothpaste production, they give up less to make one tube of toothpaste.

Who should make toothbrushes?

In Manchester, the “price” of one toothbrush is 1 tube of toothpaste.

In Liverpool, the “price” of one toothbrush is ¼ tube of toothpaste.

Thus, Liverpool has the Comparative Advantage in toothbrush production, they give up less to make one toothbrush.

Urban EconomicsThe Creation of Urban Areas

Comparative Advantage Before Trade

Manchester

• In one labor year, they produce 13,000 toothbrushes

• In one labor year they produce 13,000 toothpaste tubes

• Not enough dental hygiene products for the whole city

Liverpool

• In one labor year, they produce 40,000 toothbrushes

• In one labor year they produce 10,000 tubes of toothpaste

• Not enough dental hygiene products for the whole city

Combined

• Without trade, they cannot share one another’s advantages

• Total toothbrush production is 53,000 units

• Total toothpaste production is 23,000 units

Urban EconomicsThe Creation of Urban Areas

Comparative Advantage After Trade

Manchester

• Makes toothbrushes only

• In one labor year, they produce 80,000 toothbrushes

• They can trade some of these for toothpaste

Liverpool

• Makes toothpaste only

• In one labor year, they produce 26,000 tubes of toothpaste

• They can trade some of these for toothbrushes Combined

• Total toothbrush production is 80,000 and total toothpaste production is 26,000

• Comparative advantage leads to trade because when they both specialize total production of both increases

• Now they trade and have sufficient dental hygiene products for everyone

• Trade and specialization lead to mass production which leads to urbanization

Urban EconomicsThe Creation of Urban Areas

Scale Economies, Trade and Urbanization

La

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in H

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Un

it

Volume of Product

Average Labor Time

The average labor time per unit decreases as the quantity of the product increases due to factor

specialization and indivisible inputs.

In a competitive market, firm size increases as firms have an incentive to produce large volumes in order to

take advantage of the economies of scale.

The existence of large firms will demand a larger pool of nearby employees who will receive premium

compensation and drive the process of urbanization.

Urban EconomicsThe Creation of Urban Areas

Scale Economies and the Market Area of a FactoryUnderstanding the market area of a factory helps us understand how far the influence of the city extends.

Activity will develop proximate to the factory because people will travel to trade.

The market area of a factory is the area around the factory where the cost per unit of factory production plus the variable cost of the transportation are, together, less than the cost of a homemade or rival producer’s product.

Each factory in a city will have a different area of influence, some drawing labor and materials from shorter or longer distances.

The greater the competitive reach of the product, the larger the zone of the urban influence.

Greater economies of scale cause larger market areas for the factory and increase the drive to urbanization.

Inside the circle shows the market area of a soap factory. In this area people buy factory soap because it costs less

Miles from factory

Cost of homemade soap

Cost of factory soap

Net

cos

t of s

oap

Travel Cost

Factory Cost

Outside of the circle, homemade soap is less expensive and people buy it instead.

Urban EconomicsThe Creation of Urban Areas

Transportation and the Urban Area

Transportation Costs erode gains to trade. Thus,

Low cost routes/low cost technologies are preferred and

areas with transportation access have the advantage that comes with lower transportation costs.

Cities of choice vary as logistic costs vary overtime.

For example, the Panama Canal and Suez Canal both changed ocean shipping patterns, benefiting some cities (both port and inland) and hurting others.