Chapter 3: Big and Small Cities

One of the purpose of this chapter is to provide some insight into why cities vary in size and scope, addressing the question Why aren’t all cities the same size?

LOCALIZATION ECONOMIES AND INDUSTRY CLUSTER

The clusteering is puzzling because dispersing into separate territories would reduce competition for worker and perhaps brings firms closer to their dispersed costumers. There are some subtle benefits from clustering: sharing the suppliers of intermediate inputs, sharing a pool of labor, and sharing information. The label these external economies is “localization economies” indicating that the cost savings occur only for local firms

Sharing Input Supplier

Some industry clusters occur because firms in a particular industry buy an intermediate input from the same supplier. Firms will cluster around a common input supplier if two condition are satisfied:

1.      The input demand of an individual firms is not large enough to exploit the scale economies in the production of the intermediate input.

2.      Tansportation cost are relatively high. Similiarly, if the intermediate input is bulky, fragile, or must be delivered quickly, proximity is important.

There is evidence of clustering based on input sharing. If a firm face  uncertain and rapidly chaning demand for its product, it will be small and agile, and will have an incentive to share input supplier.

Sharing a Labor pool: varying Demand for Labor

A firm faces two sorts of questions about its future labor demand:

1.      How many workers will we hire?

2.      What sort of labor skill will we need in our workers?

If a firm is uncertain about the quantity of workers it will hire or the skills of its workforce, it will have an incentive to cluster around other firms and draw from a common labor pool. Eventually, the workers in the unsuccessful firms will move to the succcessful one. Worker also can easily switch to a different firm in the city

Benefits and Costs of Labor pooling

Consider a software firm that has two equally likely outcomes in a particular year: good times or bad times. In good times the price of its product is high, so the firm has a relatively high demand for labor. In bad times the price of its product is low, so the firm has a relatively low demand for labor.

Consider the trade-offs associated with moving the firm from the isolated site to the industry cluster with the labor pool, the benefits of moving to the cluster is that during good times, the firm would pay a lower wage and earn more profit.

Sharing a Labor pool: Matching

Consider next issue of uncertainty about what sort of job skills a firm will require. Although a firm probably knows what sorts of labor skills it needs this year uncertainty about the future demand for its product and future production technology causes uncertainty about the firms future needs for labor skills. A large labor pool near an industry cluster provides a wider variety of skills for firms to tap.

Sharing information: knowledge spillovers

A city provides opportunities for intyeractions among people with common interest and thus promotes creative thought. There is evidence that knowledge spillovers encourage industry clustering . knowledge spillovers increase number of new plants births, with the largest effect on industries that employ college. knowledge spillovers are strongest in industries with many small, competitive firms.

URBANIZATION ECONOMIES

Urbanization economies differ from localization economies in two ways. First, urbanization economies result from the scale of the entire urban economy. Second, urbanization economies generate benefits from firms throught the city. They are similar to localization economies in the sense that they arise for the same reasons

1.      Intermediate inputs. Firms from different industries share the suppliers of intermediate inputs, allowing the realization of scale economies in the provision of business services.

2.      Labor pooling.  If  fluctuations in the labor demands of different industries are not correlated, workers in a declining industry can easily switch to a growing industry

3.      Sharing information. The knowledge spillovers lead to innovation in product design and production methods.

EVIDENCE OF EXTERNAL ECONOMIES

In searching for evidence of localization economies, researchers focus on the effects of industry concentration on (1) worker productivity, (2) the number of new production plants, (3) growth in industry employment.

Evidence of Localization Economies

Localization economies as the elasticity of output per worker with respect to industry output, defined as percentage change in output per worker divided by the precentage change in industry output. Agglomeration effects in the office sector  are much more powerfull than those in manufacturing. In addition, the agglomeration effects are largest in the area of the city where the increase in office employment occurs. The benefits associated with localization economies fall rapidly with distance.

The Incubation Process

Localization and urbanization economies are responsible for the incubation process. Product cycle theory of industrial location: product are developed by small firms in areas that allow sharing of inputs and knowledge spillover. When the product becomes standardized, the firm can produce it on a larger scale in its own production facilities.

DIFFERENCES IN CITY SIZE

In this chapter, we’ve seen why some types of firms cluster in cities

Localization Economies

Industries vari in the strength of their localization economies. Some industries experience subtantial cost savings from input sharing, labor poolong and information spillovers, while others experience relatively small cost savings. The stronger the localization economies, the greater the incentive for firms to form an industry cluster with large concentration of employment.

Urbanization Economies

Consider next the role of urbanization economies, the spillover benefits that result from the scale of the entire metropolitan area not just a particular industry. Firms in an industry subject to urbanization economies are attracted to large metropolitan areas and this tend to make large cities larger.

The Role of Consumer Goods

in fact, workers in a city spend some of their income on consumer product provided within the city. The jobs supported by local consumer spending is often labeled local employment. Some product are available in all cities, large, medium, and small. If product has large per capita demand relative to scale economies in production, even a small city will generate enough demand to support a firm producing the product.

AGGLOMERATION ECONOMIES IN MARKETING: SHOPPING EXTERNALITIES

A shopping externalities occurs if the sales of one store are affected by the location of other stores. These shopping externalities cause firms selling related product to form retail clusters. Some retail cluster cause the development of market cities. Other clusters within large cities, generating downtown shopping areas, malls, and shoping centers. There are two types of product that generate shopping externalities: imperfect substitutes and complement.

Imperfect Substitutes

Two goods are imperfect substitutes if they are similar but not identical. For these goods, the clustering of firm selling similar product decrease shopping cost and attracts potential buyers. Some retailers cluster in the city center, while others cluster  in shopping centers and malls.

Complementary Goods

Complementary goods are often purchased on the same shopping trip. The shoe store will benefit from the presence of the pants store because together they provide one stop shopping for consumers. Because of the benefit of one stop shopping, firms selling complementary goods cluster in shopping centers.

INNOVATIONS IN TELECOMUNICATIONS AND THE FUTURE OF CITIES

An improvement in telecomunications has two effects on the number of face to face contacts

·         In a given relationship, some face to face encounters will be replaced by telecomunication: An investment banker could e-mail a client instead of meeting her for a brief conversation; the banker could fax a contract instead of delivering it by hand

·         Easier communication may increase the number of relationships. An investment banker could consult with more people in the process of evaluating the merits of particular project; the banker could handle more projects.

Innovations in telecommunication technology will not cause cities to didappear because some activities require face time, so there will always be a need for cities and the physical proximity they provide.

A shopping externality occurs if the sales of a perticular store oncrease as other retailer move closer to the store. These agglomerative economies in marketing cause the clustering of retailers.

Chapter 2: Why Do Cities Exist?

Cities Exist because it is efficient to produce some goods on large scale, and in this chapter, cities exist because the benefits associated with concentrated production more than offset the costs of living in a high population density

A Region Without Cities

This model provides a list  of assumptions that together preclude the development of cities. A region only produces and consumes two goods: shirt and bread. People use land to grow raw materials and take time to produces it. Travel within the region is by foot. The following assumptions together preclude urban development

1.      Equal productivity. All resident are equally productive at producing bread and shirts

2.      No scale economies in production. The amount of bread produced per hour is independent of the volume produced

3.      No scale economies in transportation. The transport cost per unit shipped per mile is independent of the volume shipped

This assumptions eliminate the possibilityof trade. There are no advantages from trade or centralized production, so every household in the region will be self-sufficient. The higher demand for land at that location would bid up the price of land, and household living in the concentrated would be worse off than those living elsewhere. In this equilibrium, there would be costs from concentrated production ,m but bo benefits, so there would be no cities.

TRADING CITIES

Trading cities developed to facilitate trade between people in different parts of a region

Comparative Advantage Generate Trade

If the assumptions in region without cities is relaxed, one part of the region may have a comparative advantage in shirt production, and the other part may have a comparation advantage in bread production. Its possible-but not certain-that comparative advantage will cause specialization and trade

Trade between the two household will be beneficial if the transportation costs involved in trading aren’t too large. And household in the two region will specialize and trade, exploiting their comparative advantages to increase consumption.

Although there is now specialization and trade, there will not be any cities. Based no scale economies in transportation assumption, household in two region will engage in direct trade.

Scale Economies in Transportation and Trading citties

To fully exploit scale economies in transportation, a trading firm must collet and distribute a large volume of output. A trading firm will locate at a place convenient for the collection and distribution of  goods. The location decision of traders cause the development of market cities. People employed by the tradingfirm will live near the marketplace to economize on commuting cost and will bid up the price of land near the market place. The population density around the marketplace will be higher than in the rest of the region.

FACTORY CITIES

If we drop the assumption of constant return to scale and introduce scale economies in the production of shirt, factory production may replace home production, causing the development of factory cities.

Scale Economies and the Shirt Factory

As the volume of production increases, the labor required to produce one shirt decrease. Scale economies arise for two reason:

1.      Factor specialization. The specialization of labor increase productivity because (a) a worker productivity increases with repetition and (b) a worker spends less time switching from one production task to another

2.      Indivisible input. An input to the production process is indivisible if the input has a minimum efficient scale.

A Factory City

The factory city develops because two conditions are satisfied. First, agricultural productivity is high enough that worker outside the city can generate enough food to feed themselves and have enough left over to feed the shirt worker in the city. Second, scale economies are large relative to travel costs.

LIMIT TO CITY SIZE: COMMUTING COSTS

In this point, we assumed that the wage paid to factory workers is independent of city size. But in fact, the wage paid to factory workers wil increase as the city grows because bigger cities have longer commuting times. The factory must compensate workers for longer commutes, so the wage will increase as the city grows. As the wage increase, so does the cost of factory shirts relative to the cost of homemade shirts.

HISTORICAL INSIGHT: A BRIEF HISTORY OF WESTERN URBANIZATION

This part of the chapter takes a historical prespective, dicussing how changes in technology cities to  grow and shrink, and eventually caused urbanization aroun the world.

The First Cities

Most agree that the first cities served both religious and defensive purpose.

Consider first the defensive city. The people working in fortified storage facilities, will live near the facility, generating a place with a relativity high population density, a small city. This is the theory of the defensive city: the first city developed because of scale economies in the storage of agricultural surplus.

Consider next the religious city, the development of the first cities coincided with development of large scale religion. The small shrines in home and village were replaced by large tamples at central location and caused the development of a place with relatively high population density, a city. This is the theory of the relihious city: the earliest cities developed because of scale economies in the provision of religion.

The centralization of power during the mercantile period caused the development of administrative cities and reduced trede barriers. Combined with efficient ocean travel, this resulted in the development of trading cities.

The rapid urbanization in the nineteenth and twentieth centuries was caused by the industrial revolution and the associated innovations in agriculture, transportation, and manufacturing.