ECONOMICS OF THE
METROPOLITAN AREA
212G, SPRING 2013
Professor: Keren Mertens Horn
Office: Wheatley 5-78B
Office Hours: TR 2:30-4:00 pm
E-mail: Keren.horn@umb.edu
WHY DO CITIES EXIST?
 US Cities:
 In 2010, 84% of the U.S. population lived in urban areas, up from
62% in 1960 and just 6% in 1800.
 Internationally:
 Today roughly half of the world’s population lives in urban areas, up
from 30% in 1950
 As countries develop they tend to become more urbanized.
 In developed world roughly 75% of the population lives in urban areas
 In less developed countries roughly 45% live in cities
 Cities are getting larger
 Over last 30 years NYC grew at an annual rate of about 0.5%,
Mumbai by 3.1%, Dhaka by 5.6%
 Given that the world’s population continues to urbanize and
cities continue to grow, can we explain why this happens?
INCREASING RETURNS TO SCALE!
 Most important economies of scale for urban economics is
called Agglomeration
 An agglomeration economy exists when production is cheaper
because more activity is going on nearby
 Two types of agglomeration economies:
 Localization Economies
 Economies of scale that arise from have many firms in the same industry
locate near one another
 Urbanization Economies
 Economies of scale that arise from having many people located together,
regardless of the industry in which they work.
 Sources of agglomeration economies?
SPECIALIZATION
 Why do cities facilitate specialization?
 Cities provide sufficient demand to support a large supply of
specialized services and organizations
 Adam Smith “The division of labor is limited by the extent of the
market”
 Why does specialization aid productivity?
 It makes production cheaper and smoother
 Thinking about the business of curing cancer. In a large city, such as
Boston, we have many doctors that specialize in curing particular types of
cancer. Then within specialties, there are subspecialties. A dermatologist
can specialize in Mohs, which has a very high cure rate (98%) and can
minimize the amount of skin that needs to be removed.
 Specialization can arise from both Localization Economies and
Urbanization Economies
 Chicago stockyards example of localization
 Organization of ultra-marathon runners example of urbanization
DEMAND SMOOTHING
 “Economies of scale that arise because larger organizations
have less need for down-time between demands on their
services”
 Again if we think about curing cancer:
 Small cities there are times when no one will be in need of a doctor
who specializes in Mohs surgery.
 Large city more likely there will always be a need for a doctor who
specializes in Mohs, and many other specialties.
 Demand Smoothing can arise from both Localization
Economies and Urbanization Economies
 An advertising agency that specializes in non profit campaigns will
have much less down time in Washington DC than in Topeka Kansas.
 Organization of ultra-marathon runners example of urbanization
INTERMEDIATE INPUT
ECONOMIES OF SCALE
 What are intermediate inputs?
 Things used to make other things – Screens used to make
Televisions, Engines used for Cars.
 Interpreted more broadly a night at the Opera could be an
intermediate input as it is used to make the lives of city residents
more pleasant.
 There are economies of scale associated with having all these
‘intermediate inputs’ located nearby.
 It is cheaper to make TVs when the screens don’t have to be shipped
long distances (ex of Localization Economies)
 Firms benefit from employing people in places that already have
sewers, childcare, restaurants and theater (ex of Urbanization
Economies)
EXTERNALITIES
 What are externalities?
 “An uncompensated impact of one person’s actions on the well -being
of a bystander.” (Mankiw)
 “A cost (benefit) that is not borne directly by the person who decides
about incurring it.” (O’Flaherty)
 Ex/A cup of tea can have a positive externality, if my good mood as a
result of drinking the tea during class spreads to all of you (or helps
me communicate this material in a clear fashion).
 Knowledge Spillovers is key positive externality that arises
from density.
 Firms in the same industry can learn from each other if they are
located nearby and improve their production techniques (ex/Silicon
Valley)
 Firms in different industries can take techniques used in one industry
and apply to a different industry. (ex/If a bookstore comes up with an
innovating marketing technique, and real estate agent next door
could learn from them and improve their business)
LOWER SEARCH COSTS
 Takes less time and energy to find what you are looking for!
 Employers can more easily find exactly the right person for a job.
(ex/Global Fraud Analyst)
 Consumers can more easily find exactly the product they are looking
for in a large city (ex/A bilingual day care center)
 Implications:
 Businesses that involve physical searching should be located in cities
(ex/Diamond District in NYC)
 Lower search costs lead to better matches (Less likely to settle or pay
more for a product)
 Avoids ex post opportunism – when one party has to make an
investment that is worthless without the other party (a new Opera
House becomes worthless if the city no longer has an Opera)
EVIDENCE?
 These are theories crafted by economists to explain why cities
exist, but are they true?
 How could we test them?
 Evidence from Economic Research on Agglomeration
 Wages are higher in cities
 Glied (1997) in 1994 per capita personal income was 35% higher in
metropolitan areas than in non-metropolitan areas
 Urban wage premium increases over time
 Glaeser and Mare (1994)
 Urban wage premium does not go away when a worker leaves the city
 Glaeser and Mare (1994)
INNOVATION
 About 45% of US new product innovations occur in 4
metropolitan areas – New York, San Francisco, Boston and Los
Angeles (Feldman and Audretsch, 1999)
 Why are cities hotbeds of innovation?
 Interaction and Diversity – lots of people from lots of backgrounds
coming together
 New ideas harder to communicate over long distances – inventions
can spur further inventions
 Easier to bring innovation to market – faster you can find your
intermediate inputs the faster you can turn your idea into a reality
 Job turnover is high – less risk of leaving a job to try and turn an idea
into a business
NEGATIVE EXTERNALITIES
 Are some negative consequences associated with clustering:

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Congestion
Pollution
Disease
Crime
High Rents
 If not addressed these negative externalities can wipe out all
the positive things that cities promise.
DO WE STILL NEED CITIES?
 In the age of the internet and telecommunications, do cities
still matter?
 Many believe technology provides a fundamental threat to the
existence of cities
 Question is whether electronic communications are complements or
substitutes of face-to-face communications?
 Complements – two goods for which an increase in the price of one leads
to a decrease in the demand for another (consumed together like milk and
coffee)
 Substitutes – two goods for which an increase in the price of one leads to
an increase in the demand for the other (one takes the place of the other
like coffee or tea)
 As transportation costs continue to decline, internet shopping
continues to grow, and electronic communication becomes
easier will cities become less or more important?
REVIEW OF ECONOMIC CONCEPTS
 AGGLOMERATION
 An agglomeration economy exists when production is cheaper because more
activity is going on nearby
 LOCALIZATION ECONOMIES: Economies of scale that arise from have many
firms in the same industry locate near one another
 URBANIZATION ECONOMIES: Economies of scale that arise from having many
people located together, regardless of the industry in which they work .
 EXTERNALITIES
 An uncompensated impact of one person’s actions on the well -being of a
bystander.
 COMPLEMENTS
 Two goods for which an increase in the price of one leads to a decrease
in the demand for another (consumed together like milk and coffee)
 SUBSTITUTES
 Two goods for which an increase in the price of one leads to an increase
in the demand for the other (one takes the place of the other like coffee
or tea)