1. Urban and Regional Economics Prof. Clark
Week #2

2. Agglomeration Economies
Externality in production.
What is this?
Q=G(N)*f(K,L)
N=indicator of city size or industry size
Note that the agglomeration effect, G(N) is external to the firms’ production function, f(K,L,D)
Economies of Agglomeration: MG/MN>0
Diseconomies of Agglomeration: MG/MN<0

3. Agglomeration Economies and Diseconomies
Cost
(time)
DR to external
economies
IR to external
economies N

4. Urbanization Economies
N is size of city
Cost savings from being in larger city.
Better business services (greater variety).
Economies of scale in input supply for all industries.
Local labor market efficiencies
Complementarity (e.g., secondary labor market)
Economies from interaction - Jacobs argument
Inter-industry knowledge spillovers
How do we know these are eventually exhausted?

5. Localization Economies
N is size of industry in which firm is operating.
This is clustering of firms in an industry
e.g., Silicon Valley, Detroit, etc.
Sources
Firm specific business savings due to scale economies in intermediate inputs.
Unique labor markets
Knowledge spillovers (intra-industry)
Can lead to Incubation process
Valuable initially, later erodes

6. Agglomeration in Marketing
Shopping externalities
Why do these exist?
Imperfect substitutability
Complementarity in goods
Shopping malls
Retail clusters
These have been changing
Why and how?

7. Article by Ray Vernon
Vernon looks at NYC in the late 1950’s and looks at a number of its disadvantages:
No natural resource advantage
high relative wages
costly commuting expenses
declining importance of port
Yet certain types of companies continue to locate there.
Why?

8. Common Characteristics
Establishments with low overhead.
Why?
Look at Tables 1 and 2
They face an uncertain future
Survival requires ability to adapt quickly.
They continue to rely upon face-to-face contact
Why not other forms of communication?

9. Look at some of his examples
Small dressmaking shops
Rapidly changing environment.
Need to meet with specialists from other firms frequently.
Military electronics
Products are unique and change rapidly.
Printing
Unique jobs
Publishing
Use of specialists

10. These are Agglomeration Economies
Urbanization or Localization?

11. Parallels to Corporate HQ’s
Many firms have their corporate headquarters in NYC.
156 of Fortune 500 in 1958.
They face uncertain future.
Corporations need to make use of banking, economic, financial, legal, accounting specialists.
Advantage of being near Wall Street.
Need to be able to respond quickly.

12. Why firms leave? Advantages can erode.
Example of insurance companies.
As technologies mature, some activities are get exported to lower cost production areas.
Radio example.
As industry grows, pull to lower cost regions grows.
More later on this.

13. Insights from article Vernon Why look at such an old article?
Insights for today?
Are things changing?

14. Empirical Evidence on Agglomeration Economics
MSAE emphasizes empirical tools.
We scratch the surface here.
Text gives other studies out there
Briefly look at findings of one paper that estimated agglomeration economies.
Looked at both urbanization and localization economics
I haven’t assigned this, but for those who are interested, the citing is:
Ronald Moomaw, “Agglomeration Economies: Localization or Urbanization: Urban Studies, 1988, Vol 25, pp

15. Overview of Moomaw
Notes that single measures of agglomeration in a production function can be misleading.
Should separate urbanization and localization economies.
Classifies 2-digit manufacturing industries according to their degree of localization (clustering near firms in same industry) and urbanization (clustering in larger urban areas).

16. Empirical Approach Take a specific form of the production function.
Assume specific form for urbanization and localization economies.
Manipulate this equation so that it can be estimated.
Mathematically derive a labor demand function based on marginal productivity theory of production.
Estimate parameters of urbanization and localization.

17. Findings
Most urbanized industries typically have significant urbanization and/or localization economies.
Least urbanized industries have no urbanization or localization economies.
Agglomeration economies are primarily localization economies.
Some evidence of diseconomies of urbanization.

18. Overview of Additional Empirical Evidence
John Quigley article – “Urban Diversity and Economic Growth” reprinted from Journal of Economic Perspectives, 1998 (Vol. 12, No. 2) pp
Presented by Mike

19. History of Urbanization
Look at figure in book (2-4)
Urbanization at about 7% in 1800
Urbanization at about 75% by 1990.
Variety of factors at work
Rapid acceleration of Urbanization during Industrial Revolution
Agricultural Revolution
Manufacturing Revolution
Construction Revolution
Mr. Otis’ contribution
Transportation Revolution
Inter- and intra-city
All were necessary, none was sufficient to generate urbanization.

20. History of U.S. Urbanization: Centralization and Concentration
1920
Centralization
Decentralization
Decon
Concentration
Concentration
1790
1970
1980

21. Brief update of metro/nonmetro growth patterns for 1990’s
Long and Nucci (Environment and Planning A, 1997, Vol. 29)
Show that nonmetro areas are still growing slower than metro areas (ie., similar to most historical time periods)
However, growth in nonmetro counties is accelerating and growth in metro counties is decelerating.
Thus: Some similarities to 1970’s trend.

22. Reasons for Decentralization
Automobile and truck have led to suburbanization of population and employment.
Income growth and blight-flight process have reinforced the process.
More later in semester.

23. Reasons for Deconcentration in 1970’s.
Gerald Carlino evaluates this phenomenon
“Declining City Productivity and the Growth of Rural Regions: A Test of Alternative Explanations”
Journal of Urban Economics, 1985, Vol. 18, pp
Presented by Rose

24. Limiting Factors on City Growth
What factors limit size of cities?
Internal scale economies
Agglomeration economies
Market size and transportation expenses
Congestion and compensating differentials
What about the role of telecommunications?
Should these strengthen or weaken pull towards cities?
Briefly review paper by Gaspar and Glaeser.
On reserve, but I have not assigned it.

25. Insights from Gaspar and Glaeser
“ Information Technology and the Future of Cities”, Journal of Urban Economics, 1998,Vol. 43, pp
Evaluates whether information technology will ultimately make it unnecessary to locate in cities
ie., move to a “spaceless world”
Two opposing forces:
Substitution effect: Telecommunications innovations substitute for face-to-face meetings.
Scale effect: Telecommuncations innovations increase frequency of contact, and hence can increase demand for face-to-face meetings.
Thus: This is an empirical issue

26. Overview of Model Theoretical Model of Interactions:
Describes choice process whereby an individual confronted with project with expected value (ie., return) must decide:
Do this privately (without making new contacts)
Do this jointly with new contacts with another person
If joint:
Face-to-face (high intensity meeting)
Telecommunications (low intensity meeting)
Discontinue contact
Develops equilibrium conditions and then does comparative statics to evaluate impact of telecommunications advances on equilibrium

27. Theoretical Findings:
As telecommunications improve, more initiated contacts will lead to more exclusive telephone relationships. (Substitution effect)
As telecommunications improve, there will be more initiated contacts, since expected return from contact increases. (Scale effect)
Conclusion:
If substitution effect dominates: Less need for city locations
If scale effect dominates: More need for city location

28. Empirical evidence Telephones and distance Business travel
U.S. evidence:
In mid-1970’s, more than 40% of phone calls made to places within 2-mile radius, and more than 75% within 6 mile radius.
Japanese evidence:
#calls between 2 perfectures=f(pop, income, price, distance)
Distance coefficient is negative and significant.
Business travel
Positive relationship between business travel and telecommunications advances

29. Evidence - continued Co-authorship in Economics Cities and telephones
Rising tendency over time
Increases number of long-distance co-authorships, but also local co-authorships.
Cities and telephones
Japanese data shows:
Minutes per household = f(income, urban status)
Positive and significant coefficient on urban status (ie., increases telephone interactions)
U.S.:
Expenditures/capita rise with city size.
Historically: telephone use rises with urbanization

30. Conclusions
Growth in telecommunications has not diminished need for face-to-face.
Innovations in telecommunications are likely complementary, not substitutes.

31. What does the future hold?
Look at another article by Glaeser:
“Are Cities Dying?”Journal of Economic Perspectives, Vol. 12(2), Spring 1998, pp
Focuses on role of “agglomerating” vs. “congesting” forces and discusses which are likely to dominate
Presented by: Joe

32. Dorian Friedman – U.S. News and World Report article
Suggests that Downtown regions are experiencing some type of renaissance.
Sparked by downtown construction of entertainment facilities
Inmigration of empty-nesters
Growth of cultural attractions
Is this consistent with other perspectives?
What type of agglomeration is emphasized here?
Do you think this is happening?

33. The Economist Article
Focuses on the revitalization of Chicago’s State Street
“Transit mall” experiment scrapped
Through-traffic re-introduced
Role of demographics
Empty-nesters (young and old)
Attraction of retailers (more later in semester)
Role of TIF districts
Some controversy
Conclusion

34. Role of Comparative Advantage
We now understand why cities exist
Internal Scale Economies
External Economies or Agglomeration Effects
Can be Localization and/or Urbanization
Now we turn to models of where cities evolve
Will consider both the locational choices of people and firms.
Two sides of labor market as well as retirees.

35. Comparative Advantage and Location of Cities
Look at cost-minimizing behavior of firms in context of model where friction of space is introduced.
Comparative Advantage:
A firm can produce a product at lower opportunity cost than firms in other regions.
Explains why regions specialize.

36. There are Two Types of Firms
Transfer Orientation
Geographic differences in transport costs are more important than geographic differences in other costs.
Cost of transportation of raw materials vis a vis finished product is driving force.
Examples include steel, autos, beer.
Local Input Cost Orientation
Geographic differences in other inputs (labor, land, capital, energy, amenities) more important than transport costs.
Pull of non-transport factors is driving force.
Examples include textiles, computers, R&D

37. Transfer-Oriented Production Firms
Start with very simple assumptions and later relax them.
Assume firm produces single output, sold at single point (market=M) and uses raw materials from single source (Forest=F).
Only one input needs to be transported. All others are ubiquitous.
There is a comparative advantage for the input at F, and it is not available elsewhere.

38. Assumptions - continued
Firm does not substitute among inputs (fixed proportions).
Firm is small in relation to input and output markets.
Transport costs are constant/mile at t.
There is single mode of transport.

39. Total Transport Costs F M Total Distance = xm
Total Transport Costs Total Transport Costs
F M
Total Distance = xm

40. Plant Can Locate Anywhere
Total Transport Costs Total Transport Costs
F Plant M
(x) (xm-x)

41. Two types of costs Procurement costs Distribution costs
These are costs associated with procuring the inputs from the forest to the plant.
PC=wi*ti*(x)
wi*ti=monetary weight
Distribution costs
These are costs associated with distributing the final product from the plant to the market
PC=wo*to*(xm-x)
wo*to*=monetary weight

42. Procurement Costs
Procurement Costs Procurement Costs
slope= wi*ti
F M

43. Distribution Costs slope= wo*to F M
Distribution Costs Distribution Costs
slope= wo*to
F M

44. Combining two costs Total Transport Costs Cost min. F M
Total Transport Costs Total Transport Costs
Total Transport Costs
Cost
min.
F M

45. Question: What determines the optimal location
Compare the monetary weights of the inputs and the output.

46. Market Orientation (aka-weight gaining process)
Total Transport Costs Total Transport Costs
wi*ti <wo*to
Cost
min.
F M

47. Materials Orientation (aka-weight losing process)
Total Transport Costs Total Transport Costs
wi*ti >wo*to
Cost
min.
F M

48. Why do we always get endpoint solutions?
Because monetary weights are constants.

49. Adding realism
Terminal costs are costs associated with loading and unloading
These increase if you locate at intermediate locations.
Nonconstant values for ti and to.
we expect t falls with distance shipped.
Look at implications for our model

50. Transport Costs function of distance
Total Transport Costs Total Transport Costs
Total Transport Costs
Cost
min.
F M

51. Adding in Terminal Costs
Total Transport Costs Total Transport Costs
Cost
min. T
F M

52. Question: Does realism increase or decrease the likelihood of an endpoint solution?

53. Allow multiple markets
Assume inputs are all ubiquitous.
Keep simple assumptions of constant transport costs.
If transportation costs are important, then firms will choose Median location
Assume each input weighs 1 lb. and transport costs per mile are $2.00.
Monetary weight per customer=wo*to=1*2=2
Assume markets are 1 mile apart.

54. Principle of Median Location: Distribution of Customers and Monetary Weight
Middle Point
43 customers
43 customers
Customers:
MW=wo*to:
Sum of MW: $ $86
Miles from
midpoint:
Total Costs:
= $426

55. Proof by Contradiction
Alternative Point
44 customers
20 customers
Customers:
MW=wo*to:
Sum of MW: $ $40
Miles from
midpoint:
Total Costs:
= $428

56. Question: Why does this happen?

57. Other Input Cost Orientations
Other types of costs may matter more to firms. These include:
Labor Orientation
Amenity Orientation
Energy Orientation
Land Orientation
External Economy Orientation
Fiscal Orientation

58. Graphical depiction
Suppose that one location has lower labor costs than another.
e.g., South has more right to work laws, and lower unionization rates.
We can adapt our most simple model.
Look at balancing of labor and transport costs.
Assume one kind of transport costs.
Assume labor costs decline with distance.

59. Labor Oriented Firm Cost min. Labor Costs Distribution Costs
Transport+Labor Costs Transport+Labor Costs
Cost
min.
Labor Costs
Minimum
Labor
Costs
Distribution
Costs
M Low cost Labor

60. Two types of Orientations
What have we observed over time?
Transport costs have continually declined.
Reasons:
Lighter materials
More efficient transport modes
Container systems on ships
Deregulation of trucking
Development of interstate highway system
Internationalization of markets generating other input cost differentials.

61. Next time - Look at Firm Location and Household Location Decisions
Bartik – Clark will do this one
Leichenko
Household Location
Clark and Hunter
Broad Regional Trends
Chinitz