URBAN ECONOMICS

• Firms maximizing profits cause the development of cities  in different locations

1.  Local inputs

• Inputs that cannot be transported

Ex. - Climate, soil, special features

• Firms utilizing local inputs must locate near them

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2. Transport-intensive firms

• Transportation cost is a large fraction of the firm's total cost

a. Assumptions

(1) Single transportable output - transported from production facility to output market

(2) Single transportable input - all other inputs ubiquitous (available at all locations at the same price)

(3) Fixed factor proportions - no factor substitution

(4) Fixed prices for inputs and outputs

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b.  Profit maximization

Profit = TR - (input costs + transport costs)

• Firm maximizes profit by choosing location that minimizes total transportation cost

• TR and input costs are the same at every location

• Only transport costs vary

c.  Transport costs

• Total transportation cost = input transport cost + output transport cost

• Input transport cost (ITC) - cost of transporting raw materials from input source to factory

• Output transport cost (OTC) - cost of tranporting firm's output from factory to consumers

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d. Resource-oriented firms

• Relatively high cost for transporting inputs => pull towards input source is relatively strong

Monetary weight = physical weight * transportation rate

ITC = w_i * t_i * (d - x)

OTC = w_Q * t_Q * x

w_i = weight of input

t_i = transportation rate for input

w_Q = weight of output

t_Q = transportation rate of output

d = distance from input source to market

x = distance from factory to output market

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• Firm locates near input source if monetary weight of inputs is greater than the monetary weight of outputs

w_i * t_i > w_Q * t_Q

• Resource-oriented activities:

(1) Weight-losing activities - weight of output less than weight of inputs

Ex. - Ore processors

(2) Other activities - cost of shipping inputs higher than cost of shipping output (bulky, perishable, fragile, hazardous)

Ex. - Cotton baling, canning

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e. Market-oriented firms

• Relatively high cost for transporting output => pull towards market is relatively strong

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• Firm locates near market if monetary weight of inputs is less than the monetary weight of outputs

w_i * t_i < w_Q * t_Q

• Market-oriented activities:

(1) Weight-gaining activities - weight of output more than weight of inputs (add ubiquitous inputs)

Ex. - Soft drinks, beer

(2) Other activities - cost of shipping outputs higher than cost of shipping input (bulky, perishable, fragile, hazardous)

Ex. - Automobile assembly, bakery, explosives

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3. Principle of median location

• Suppose multiple input sources and/or markets

• Optimum location is the median transport location - location that splits the total monetary weight in half

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a. Multiple markets

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b.  Large cities

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c.  Transshipment points

• Point where good is transferred from one transport mode to another

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• Other sources of employment and population:

- Salespeople and other intermediaries (e.g., wholesalers)

- Transportation firms (truckers, sailors, longshoremen, etc.)

- Business services (banking, insurance, accounting, etc.)

- Retailers

Ex. - New York, Chicago, Bay Area, Los Angeles

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4.  Other factors affecting location

• Transport costs becoming less important in location decisions

- Improvements in transportation technology have decreased shipping costs

Ex. - Fast ocean ships and containers, improved railroads and trucks, air transport

- Improvements in production technology decreased physical weight of inputs

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a.  Labor cost

• Firms shifted to areas with low wages

• Good weather leads to lower wages - compensating wage differentials

• Elasticity of business activity with respect to metropolitan wage = % change in business activity / % change in wage = between -1.0 and -2.0

- 10% decrease in wages => 10% - 20% increase in business activity

• Shift of firms from Northeast and Midwest to the South

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b.  Energy technology

• Manufacturing initially tied to water sources of energy

• Steam and electricity made energy transportable, reduced importance of energy consideration

• Cheap electricity and cheap natural gas important in a few industries

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c.  Agglomeration economies

• Locate in clusters to exploit agglomeration economies

Ex. - Silicon Valley, Research Triangle, world financial centers

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d.  Human capital

• Growth higher in cities with higher share of workforce with college degrees

• Shift from low-skilled manual labor to high skilled thinking labor

• Elasticity = % change in population growth / % change in share of adult population with a college degree = 1.2

- 10% increase in share of adult population with a college degree => 12% increase in population growth

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