NOTES OF URBAN ECONOMICS By vimal

DEFINATIONS
URBAN ECONOMICS It is broadly the economic study of urban areas; as such, it
involves using the tools of economics to analyze urban issues such as crime,
education, public transit, housing, and local government finance. More narrowly, it
is a branch of microeconomics that studies urban spatial structure and the location
of households and firms.
AGGLOMERATION ECONOMICS The external economics of scale available to
individual and firm in large concentration of pollution and economic activity. These
arise because larger market allow wider choice and greater range of specialist
service. Agglomeration economics are believed to explain the tendency of
conurbations to contain an increasing share of the population of many countries.
TWO TYPES OF A.E
URBANIZATION ECONOMICS It refers to benefits that firms in a number of
different industries receive from population and infrastructure clusters. A great
example of this is a shopping mall in this example is that stores have the
opportunity to market and sell to customers who go to the mall to visit another
store.
LOCALIZATION ECONOMICS - Are those in which firms in the same industry get
benefits from being located close together. The major benefits of localization
include the ability to draw from the same skilled group of workers, known as Labor
polling , and quicker spread of ideas among firms within the same industry,
a concept known as a knowledge spillover.
SCALE ECONOMICS - Economies of scale is the cost advantage that arises with
increased output of a product. Economies of scale arise because of the inverse
relationship between the quantity produced and per-unit fixed costs; i.e. the
greater the quantity of a good produced, the lower the per-unit fixed cost because
these costs are spread out over a larger number of goods.
TRANSPORTATION ECONOMICS -Transport Economics is the study of the
movement of people and goods over space and time. It is a branch of
economics that deals with the allocation of resources within the transport sector.
DEVELOPMENT ECONOMICS - Development economics is a branch
of economics that focuses on improving the economies of developing countries. It
examines both macroeconomic and microeconomic factors relating to the
structure of a developing economy and how that economy can create effective
domestic and international growth.
INTERNATIONAL ECONOMICS - An economics field of study that applies both
macroeconomic and microeconomic principles to international trade, which is the
flow of trade among nations, and to international finance, which is the means of
making payment for the exchange of goods among nations.
THERE ARE FIVE AXIOMS OF URBAN ECONOMICS
1) Prices adjust to achieve locational equilibrium
GO THROUGH ARTHUR
2) Self-reinforcing effects generate extreme outcomes OSULLIVANS BOOK OF
URBAN ECONOMICS
3) Externalities cause inefficiency FOR THIS
4) Production is subject to economies of scale
5) Competition generates zero economic profit

FOUR IMPORTANT MODEL OF URBAN ECONOMICS

i Rural- Urban migration model ( Haris- Tadaro model)
ii Core- periphery model ( Paul Krugman )
iii Agriculture land use ( Von Thunen model)
iv The monocentric city model ( Alonso- Muth- Mills model)

MODEL 1 HARIS- TADARO MODEL

In india migration contribute 20% of the urbanization growth over the decades.
Urban growth = net increase + net migration + reclassification
Haris- Tadaro model (1970) in this model they told the difference in wage between
the sectors lead to migration of people from rural to urban area of the country.
It assumed the urban wage should be expected or greater than rural.
M = f( E(Wu Wr)
Migration is a function of differential in wage between sectors.
Assumption of the model
1 Rural production function is concave and related to rural population.
Xr = f( Nr )
dXr/dNr > 0 d2Xr/dN2r < 0
2 Urban production function is concave and related urban population.
Xu = f( Nu)
dXu/dNu > 0 d2Xu/dN2u < 0
3 total population is fixed.
N = Nu + Nr
4 expected wage is equal to
E(Wu) = Nm/Nu multiply by Wu
Where Nm = manufacturing employment
Nu = total urban population
Wu = urban wage
5 the minimum level of wage in urban sector is fixed by wage union, minimum
wage legislation etc.
6 perfect competition in the market demonstrate marginal product in urban area
will be diminishing as urban population increase and it is increasing as rural
population increase.

Lets see this with the help diagram below

Where x-axis represent urban population and y-axis represent expected urban
wage, marginal productivity of labour in rural and urban area.
MPLr,
MPLu,
E(Wu) = Wu A

constant

N1 Nc N2 Urban population

In this curve Nu is inversely related to the marginal productivity of labour in urban

area( Blue line) and Nu is directly related to marginal productivity of labour in rural
area( Green line).
At point A ( Nu = Nr ) , So E(Wu) = Wu constant
Total population is Nu out of this ON1 is the manufacturing employment in urban
area , N1N2 is the people in searh of employment in urban area , N1Nc is the
excess employment.
Competitive equalibirum at Nc. To reach this point Haris- Tadaro suggested two
thing an economy have to do.
1 migration restriction
2 wage subsidy ( Wu Wc)
If we put agglomeration economics in model than the function will be like
Xu = fu(Nu) without agglomeration
Xu = g(Nu)fu(Nu) with agglomeration
Where g(Nu) is denote agglomeration and g > 0 and g < 0
dXu/dNu = g(Nu) = Wu for private sector

wage in urban and

rural

Wu
B

Nu

N1 N2 Nu

Below N1 no migration as Wr > Wu

At point A unstable equilibrium as Wr = Wu but Wu is increasing
After N1 urban population show decreasing function of urban wage and rural wage
shows increasing function of urban population.
At point B ( Wu = Wr) therefore stable equilibrium.
Both Haris conclusion condition are not accepted in urban economics.
In Haris Tanduro model competition equilibrium migration is higher than the urban
employment ( Nu > Nr ) for N1 to come near Nc wage rate have to fall W1 to Wc
that means it require a subsidy of ( W1 Wc ), from Nc must reduce to Nc it
cannot happen unless there is migration restriction.
Conclusion from urban economics
Presence of agglomeration externalities (agglomeration augmenting, congestion ,
resources generating cities ) in urban production.
 Q = g(A)f(X) production function
X is a vector unit
Let agglomeration from population therefore
Q = g(Nu)f(Nu)

Average product will be

Q/Nu = g(Nu)f(Nu)/Nu
Marginal product
dQ/dNu = g(Nu) for private firm
private entrepreneur not consider externality as a part of production function.
dQ/dNu = g(Nu) + f(Nu) g(Nu)/dNu
where g(Nu)/dNu is agglomeration economics and this is a social result.

agglomeration
economics

N* N** Nu
Because of agglomeration economics externality social optimum hold more
population tha competitive equilibrium. The shift in production function occur
because of agglomeration economics added in the model
 Wr
Wr

AP

MP
Nc Ns
Nu
This curve represent migration population of competitive equilibrium is less than
the migration population of social equilibrium because of agglomeration
economics. But when there is agglomeration diseconomies social optimal is less
than the competitive equilibrium.

MODEL 2
Agriculture land use ( Von Thunen )
German economist Von Thunen is best known for his writing on agriculture
production and his model of the isolated state.
Ricardo theory of Land rent based on fertility of land original and indestructible
power of the soil ( Rent depends on intristic characteristics of land topography ,
microclimate , soil quality, proximity to natural amenities like river, ocean etc.
Von Thunen model (1823) the isolated state based on the proximity of central
market or city. He presented the model of an agriculture economy organized
around a central market (CBD) central business district.
Assumptions
1 single agriculture good produced in featureless plain
2 Land is of uniform fertility in the plain
3 Transportation cost varies linearly with distance
4 Farmers take place as given, competition leads to zero economic profit in all
locations.
5 Land and labour are used in a fixed proportions to produce a fixed yield per unit
of area.
Now,
R(d) = pq wn qtd = p(p td ) wn
Where R(d) = Rent per unit area payable by a farmer at distance d
P = price of crop sold at the market
Q = output per unit area
w = wage rate per worker
n = no. of worker deployed per unit area
t = transportation cost per unit of output
d = distance to central market
pq = revenue per unit area to farmers
wn = labour cost incurred per unit area
qtd = transportation cost for transporting produce from unit area to the
 central market

RENT UNIT AREA qtd

pq wn ( constant )

Rent at central market pq wn . If it is possible to farm the land its rent will bid up
to the point where zero economic profit is d*made from farming it. d

Accesibility Premium = Extra amount a farmer is willing to pay in rent to be a unit

distance closer to the CBD = qt
Closet distance d* to the central market at which land rent is zero = extensive
margin of cultivation is determined by the quation
R = pq wn d=0 at market
At the market boundary ( edge )
R=0
pq wn qt(d) = 0
qt(d) = pq wn
d* = pq wn / qt = 1/t ( p wn/q )

Beyond d* farmers will be willing to cultivate land if rent payable is negative they
will leave the land fallow ceteris paribus.
Conclusion from model
1 t increase => d* increase ( due to improvement in technology )
2 p increase => d* increase
3 q increase => d* incrase ( due to improvement in agriculture technology )
4 w increase => n increase => d* decrease
1

Is the maximum rent a farmer is willing to pay for using land to cultivate a crop at a
particular location = amount that drives economic profit to zero.
Bid rent on land for cultivating crop 1 at distance d from the central market
B1(d) = p1q1 w1n1 q1t1d
rent gradient for crop 1
Bid rent on land for cultivating crop 2 at distance d from the central market
B2(d) = p2q2 w2n2 q2t2d
Rent gradient for crop 2

Bid rent/ unit area

d
distance
Blue line show bid rent function of crop 1 and red line show bid rent function crop
2.
Principle 1 ) At each location, land goes to that use which bids the most for it.
Principle 2 ) At each location, land rent equals the maximum of the bid rent there
and zero.
 Bid rent / unit
area

O d1 d2

Before d1 ( land deployed in crop 1 ) from O to d1 crop 1 farmer bid more for land
than crop 2 farmers land will be deployed in crop 1 . competition between crop 1
farmers drives land rent to the point where crop 1 farmers makes zero economic
profit.
Simlarliy for crop 2 between d1 to d2.
If both crops are planted in equilibrium , than the crop with steeper bid rent
function ( i.e. with greater accessibility premium ) will be more centrally located.
Under competitive condition ( with no market failure ), land market allocate land
to Highest and best use.
MODEL 3
Core periphery model ( Paul krugman )
Paul Krugman is an American economist. He was awarded Nobel memorial price
for economic science in 2008 for his contribution of new economic geography and
new trade theory.
The core- periphery model basically depend on transport cost, economic of scale,
share of manufacturing in national income and factor mobility. In order to realize
scale economics while transport cost, manufacturing firm will tend to locate in the
region with larger demand, but the location of demand or market itself depend on
the distance of manufacturing.
When worker migrate, they move with their own production and consumption
possibilities. The intersection between centripetal and centrifugal forces make
spatial emerge and change overtime.
Lets take two region, two sector ( Agriculture and manufacturing ) and two types
of workers farmer and worker.
Agriculture Manufacturing
1 homogenous product is produced hetergenous product is produced
2 production function shows constant production function shows increasing
Return to scale return to scale
3 farmer are only input of production worker are only input of production
4 perfect competition in market monopolistic competition in market
with economics of scale

Each firm produce variety of product with one product related to one production
function. Worker are freely mobile, but farmer are immbolie, So they divided
equally between the region.
Agriculture good traded costlessly between the two region but manufacturing
good tradedwith positive transportation cost. Labour force fixed in short run, but
responds in real wage movements in the long run.
Firms and household are subject to optimum behavior.
Demand side : circular causality
If there are large no. of firm (N) in the market produce variety of product it imply
higher output (Q) therefore price will decrease (P) because of scale economics and
low cost of transportation. Demand for worker increase in that region and nominal
wage worker get higher real wage W/P ( Lower price ) attracting migration from
other region. The increase in no. of worker ( consumers ) create a larger market
than the other region, leading to home market effect (HME).
Centripetal force generated through a circular causation of backward and forward
linkage ( the incentive of worker to live close to producer of consumption good )
and backward linkage (the incentive of producer to locate close to larger market ).
Therefore low transportation cost in the market and the expenditure on
manufacturing good is large.

Expenditure shifting

The productive
factor and its Production shifting production shifting
owner move
together
Expenditure shifting
Demand side
Supply side : circular causality
When some industry moves to big region, shifted migrated firms output become
cheaper in big region and dearer in small region. Cost of living falls in big region
due to increase in nominal wage, lower price and low transportation cost. Market
in big region gets bigger, and market small region gets smaller. Some worker move
from small region to big region got attracted by low cost of living. Some, more firm
got attracted from small region and migrate to big region.

Cost shifting

Production shifting production shifting

Cost shifting
Supply side

Cenripetal forces
1 market size 2 agglomeration economics 3 variety of product 4 backward and
forward linkage 5 face to face contract
Centrifugal forces
1 high land and housing prices 2 shortage of immbolie factor 3 high costs of non-
traded goods 4 competition with other firms
Suppose the market with sacle economics in the economy
Total market size = S
= share of mobile factor in the market
= Transport cost
F = fixed cost
Suppose total market divided equally between two region north and south
NORTH SOUTH
Market size= S/2 Market size = S/2
= the mobile of manufacturing S(1 )/ 2 consumption of
manufacturing
sector good
F > S( 1 )/2 Transport cost = S(1- )/2
Note centripetal is accepted if fixed cost is greater than the S( 1 )/2
If there is industrial revolution than F/S increase imply increase.
If there is transportation evolution than decrease.
Core- periphery structure emerges as the equilibrium of a system of opposite
effects. High TC ( in both region manufacturing share stable equilibrium ) , low
TC ( agglomeration of economics activities occur within a single region M- share 0
or 1 stable equilibrium.

1
Share of
manufacturing stable (1/2)

TC
Black, red and orange all show stable equilibrium but At black line there is only
agriculture good produced with no manufacturing share ( 0 ) , 1 represent higher
market share of manufacturing sector in market .
Snow ball effect ( reach low TC )
Inter regional migration may be sluggish because some worker have good match
with their region of origin and choose not to migrate . thus, often reaching a peak,
the manufacturing sector gets dispersed effect of non- economic factor.
Therefore the relationship between the TC and the degree of spatial concentration
is bell shaped.

Dispersion agglomeration
Unstable

0
Area under the bell curve is where equilibrium is unstable.

MODEL 4
The monocentric city model ( Alonso- muth- mills- model)
Assumption
Fixed population with identical househlods each consuming land and a genetric
consumption good
Each household supplies a unit of labour
Single generic good is produced by labour alone
All non- residential activity occurs at CBD a point in space
Everyday each household commutes to CBD to work and shop
Transportation cost varies with distance TC = f(d) = td for simplicity
ONE HOUSEHLOD GROUP : FIXED LAND SIZE
Spatial Equilibrium Models can be defined as models which solve the simultaneous
equilibria of plural regional markets under the assumption of existence of
transportation costs between two regions.
N = no. of household
L = land size ( assumed to be fixed)
C = household consumption of generic good
d = distance from CBD
t = household commuting cost per unit distance
w = wage rate
r(d) = land rent at distance d from the CBD
Spatial and locational equilibrium holds if each household spends the same
amount in land rent plus commuting cost or,
r(d)L + td = constant
*d2 = NL or d* = ( NL/)1/2 where d* is cities edge
Spatial indifference or spatially uniform utility condition can be expressed by
r(d) = - td/L + K where K is a constant
slope of Bid rent function is r(d) = - t/L .(1)
A household living 1 km further from the CBD, incurring t more in TC, pays less t in
land rent , so as to be spatially indifferent , and hence, t/L in land rent per unit area
called the accessibility premium.
Boundary for urban area r(d*) = rA ..(2)
At the city edge we have r(d*) = -td*/L + K
Substuting r(d*) = rA , K is determined by K = td*/L + rA
Thus, equilibrium rent function is given by
r(d) = - td/L + K = rA td/L + td*/L
= rA + t/L(d* - d )
Substuting d* gives the equilibrium rent function as:
r(d) = rA + t/L ( NL/)1/2 d )
As may be seen Bid rent r(d) is increase in rA , t and N decrease in distance d