Lecture 1: Cities triumph and cities decline
What makes cities successful or decline
Successful of cities
Urbanisation allows innovation, new ideas & spillovers, which contributes to sustainable growth.
Example of urban innovation
1. Traffic Jam: Widening a road is a conventional method, but ERP is an innovative method
2. Environmental degradation: Reduce and recycling is conventional, but the Netherlands’
first self-sustaining eco-village is innovative
Decline of cities
What is the core question of urban economics
Core question: What determines the uneven geographic distribution of economic activity?
Key theory: Spatial Equilibrium
Review of the economic concepts used in Urban Economics
1. Opportunity Cost
a. The value of the best alternative is forgone where, given limited resources, a
choice needs to be made
2. Positive vs Normative Statement
a. Positive: Objective statements that can be tested, amended or rejected by
referring to the available evidence (facts and data)
b. Normative: Subjective statements, aims to examine real economic events from
the moral and ethical point of view > opinions and reasonings
3. Surplus, deadweight loss
a.
4. Marginal Principle
a.
5. Equilibrium & Nash Equilibrium
a. Equilibrium in an economic environment means it has reached an equilibrium if
there is no pressure to change things
b. Nash Equilibrium: No incentive for unilateral deviation
i.
No single decision maker has an incentive to change his or her behaviour,
given the choices made by other participants
2 conditions to achieve Nash equilibrium
ii.
1. No single decision maker has the incentive to change
2. No regrets given the choices of other participants
Assumptions
iii.
1. Assume no single participant can move the market price in a
favourable direction: A firm cannot increase the price by
producing less; a consumer cannot decrease the price by
consuming less
iv.
Nash Equilibrium in location
1. Vendors will choose to locate at the median location and each will
get half the customers
v.
Nash Equilibrium and spatial variation in prices
1. Prices play an important role in the Nash equilibrium involving
location choices
Price adjustment
a. Housing price: Price adjustment involves in Nash
Equilibrium in order to generate the same utility level in
different environments, getting people to live in both
desirable and undesirable locations. For eg, in cities,
housing prices are relatively high to offset the better
access to jobs and other economic opportunities.
Housing prices adjust to ensure that no household is
incentivised to unilaterally deviate by changing location
b. Labour market: Workers compete for jobs in desirable
locations (require less travelling time), causing lower
wages in those more desirable locations. In the labour
market, wages adjust to get people to work in desirable
and undesirable environments. For workplaces within
CBD, workers demand a premium to work at locations
with relatively high commuting costs. Wages adjust to
ensure no worker is incentivised to unilaterally deviate by
changing workplaces
6. Comparative statics
a. The effect of a change in the value of a parameter on the value of an equilibrium
variable
i.
The parameter is a variable whose value is determined outside the market
being studied
b. Example
i.
Wage (P) and housing production (EQ)
ii.
Land policy (P) and price of land (EQ)
iii.
Congestion tax (P) and traffic volume (EQ)
7. Pareto efficiency
a. Definition
i.
It is an economic state where resources are allocated in the most efficient
manner. It is obtained when a distribution strategy exists where one
party’s situation cannot be improved without worsening another party’s
situation. This implies that resources are allocated in the most
economically efficient manner but does not imply equality or fairness.
So it is impossible to make one party better off by making someone worse
off > achieve at the expense of someone
b. How do we do better? > Pareto improvement
i.
Pareto improvement Definition: a reallocation of resources that makes at
least one person better off without making anyone worse.
To determine whether the allocation is Pareto efficient, we check for
ii.
Pareto improvement
1. Allocation is Pareto inefficient if there is Pareto improvement
2. Allocation is Pareto efficient if there is NO Pareto improvement
iii.
Example of Pareto improvement
1. Negative externalities generate Pareto inefficient allocations.
a. Air pollution caused by tons of toxic gas produced by a
firm
b. Assume one ton of sulfur dioxide increases the cost of
health care by $500, and a firm can cut pollution at a cost
of only $100 per ton. For a Pareto improvement, the
victims can pay the polluter $300 to cut pollution by one
ton. In this case, each party will be better off by $200.
Victims pay $300 to get a $500 reduction in health care,
and the polluter incurs a $100 cost and gets $300.
c. Pareto improvement could be achieved by splitting the
difference to make both parties better off by $200. Thus,
Pareto inefficiency exists.
2. Positive externalities
a. External benefit: Clustering such as good schools attract
residents to move nearby
b. Clustering is Pareto improvement in response to external
benefit
c. Market Equilibrium and Pareto Efficiency
i.
Market equilibrium is Pareto efficient when 4 conditions are met
1. No price setter. Firms do not control prices but take the market
price as given. This rule out monopolies, oligopolies, and other
markets in which an individual firm is large enough to affect the
market price
2. No external cost and benefit
3. Perfect information for consumers and producers
a. Consumers are informed about product characteristics
b. Producers are informed about the cost of serving
customers
8. Self-reinforcing changes
Lecture 2: The Origin of Cities
The Birth of Cities
Comparative advantage across space
Trading City
● Due to economies of scale in exchange (transportation), shipping is typically cheaper in
large batches. Most cities surround harbours, rivers, and railroad and highway crossings.
These cities offer advantages to large firms that ship their products to many locations.
● Railway Development: Transportation shapes a city.
● For example, Circle Line makes transportation in Singapore a lot easier. In
addition, it reshapes economic activities. After the introduction of Circle Line,
more people are likely to invest in the neighbouring estate near Circle Line.
● Shi Jia Zhuang is a good example
○ Comparative advantage: Intersect of two railway lines for the mining
industry
○ Economies of scale in exchange: development in railway
○ Economies of scale in production (more mines at lower average cost)
○ Urban Economics studies the spatial distribution of economic activities, and
transportation connects the location of these activities
Producer/Factory City:
Due to economies of scale in production, large firms exist because of internal economies of scale advantages enjoyed by firms through producing large quantities of a product
Consumption:
Large firms employ many workers, and these workers tend to live near the firm. The concentration
of homes in turn attracts stores, restaurants, and other services that cater to the residents.
A city is originated:
The original transport advantage becomes the catalyst for diverse economic activity that leads to
more activity.
Urban Economic Approaches on the Formation of a City
3 conditions originating a city
1. Comparative advantage
a. CA exists when one has the ability to produce products at lower opportunity cost
than trade partners. The region with lower opportunity cost in producing any
product has a comparative advantage over the other trading country
b. Trade will occur if the differences in opportunity cost generate a comparative
advantage. Thus, trading cities will not exist if the economy experiences equal
productivity in exchange
c. However, only specialisation and trade will not lead to developing a trading firm
i.
This is because of the second assumption of backyard production constant return to scale in production and exchange. If an individual can
exchange goods just as efficiently as a trading firm, there is no reason to
pay the firm to execute a transaction. Therefore, economies of scale must
be associated with the exchange for a trading firm to emerge.
2. Economies of scale: It is the cost advantages that a firm obtains due to input and
operation. Cost per unit decreases with an increase in scale > indicates the presence of
increasing returns to scale in production
a. Economies of scale in production
i.
Indivisible inputs: A trading firm uses indivisible inputs such as a large
wagon to collect and distribute output and a ship to transport output
between the two islands.
ii.
Specialised labours: Assign workers with specialised tasks. Specialisation
increases productivity through continuity (less time switching from one
task to another) and repetition (workers will learn the most efficient way
to accomplish a specific task)
iii.
Internal and external economies: Both give rise to increasing return of
scale of a firm
iv.
1. Net Price of a factory good = Sum of the factory price +
Household’s opportunity cost of travel to the factory to buy the
factory good
a. Unit travel cost (consumer) and net price is positive
relation because if travelling cost per unit of output
increases, it implies transportation cost increases and
hence the price of the output increases
b. Unit travel cost (workers) and market area of the factory
is negative because suppose there are two goods in the
economy to be produced. Producers of milk cannot
produce shoes and vice versa. Hence, milk producers
produce milk and exchange some units of milk for some
unit of shoe. These changes are market area. Hence, if
the cost of travel increases for workers, the market area
will decrease to prevent the increase in the average cost
of production.
2. Factor labour productivity and market area is a positive relation.
Because the higher productivity will further lower the opportunity
cost to produce the good and thus further strengthen the
comparative advantage. As a result, the market area (area of
exchange) will increase.
3. Factory price and market area is negative relation because if the
good produced in the factory is very costly and higher factory
price of good compared to the good being exchanged with, the
market area will decrease.
4. Factory capital cost and market area is negative relation, because
if capital cost increases, factory price will increase and
consequently market area will decrease.
b. Economies of scale in exchange
i.
It arises from two conditions
1. Indivisible inputs
2. Labour specialisation
ii.
These conditions will lower the transaction cost; thus, the trading firm will
be more efficient than an individual in executing trades. As a result, each
household spends less time executing trades and more time producing
the goods.
1. Transaction Cost is the opportunity cost of the time required to
exchange products
iii.
The trading firm will emerge if economies of scale are associated with the
exchange.
iv.
To fully exploit economies of scale in exchange, a trading firm will locate
in a place that can efficiently collect and distribute large output
volumes. Most likely will set up a port facility near the production factory.
c. Formation of producer/factory city
i.
Factory city develops because scale economies make factory shoes
cheaper than homemade shoes. The industrial revolution produced
innovations in manufacturing and transportation that shifted production
from the home and the small shop to large factories in industrial cities.
1. History: The key innovation of the industrial revolution was Eli
Whitney’s system of interchangeable parts for manufacturing. The
traditional craft approach was made individually and imprecisely.
Thus, the craftsmen and craftswomen needed to produce the
parts and fit them together. However, under Eli Whitney’s system
of interchangeable parts for manufacturing, the producer could
make a large batch of each part, using precise machine tools to
generate identical parts. Since they are interchangeable, unskilled
workers could be quickly trained to assemble the parts. As a
result, replacing handcraft production with standardised
production generated large-scale economies, causing the
development of factories and factory cities. So Eli Whitney’s
cotton gin promoted the development of trading cities by
boosting cotton output.
ii.
In addition, a factory town will develop around the factory. As workers will
economise the travel costs by living close to the factory, the competition
for land will increase the price. The higher price of land will cause workers
to economise on land, leading to higher population density. Thus the
outcome is a place of high population density, a factory city.
d. Conclusion
i.
The economies of scale in production with comparative advantage in
innovation in transportation gives an advantage in exchanging/trading.
These factors contribute to industrialisation and urbanisation, thus
lowering the transportation and trading cost, which decreases the relative
price of factory goods more than homemade goods, contributing to the
growth of factory cities or producer cities.
Innovation in intercity transportation
Trading cities in urban history
●
The history of urban America shows the importance of transportation in the development
of trading cities
○
●
●
Most cities served largely as trading cities for ocean trade. Because the volume of
trade was limited by the dirt roads serving the interior trade. As the travel was
always slow in times of rain and melting snow.
Innovation
○ Turnpikes: Built with stone and gravel. Increased travel speeds to steady two miles
per hour, increasing market area and trading volume
○ Canals; built-in 1825: Linked New York City’s natural harbour to vast agricultural
areas to the North and West. The additional canal connecting Lake Champlain to
the Hudson River extended the market area of New York City to Northern New
England. A vast transportation network increased the volume of trade through
New York City, increasing its size. By 1850, New York City had a population of half
a million, about 20 times its size at the end of the American Revolution.
○ Steamboats: Before the introduction of the steamboat in 1807, traffic was strictly
downstream. After loading cargo at the terminal, wooden boats were broken up
for lumber. The steamboat allowed two-way traffic and cut river freight costs,
increasing the volume of trade and size of river cities
○ Railroads: Shift from rivers to railroad caused the decline of commercial cities
along rivers and the rise of cities along the vast railroad network
Conclusion: Thus, innovation in intercity transportation contributed to industrialisation
and urbanisation. As dirt roads of the 1700s were replaced by turnpikes for efficient
transportation, the construction of canals allowed a more dense network of inland water
transport. Steamships allowed two-way travel on major rivers, and the railroad system
increased the speed and reach of the transportation system. Overall, innovation in
intercity transportation decreased the relative price of factory goods, contributing to the
growth of factory cities.
Lecture 3: Urban Agglomerations
Urban Agglomeration Economies
Definition
Besides comparative advantages and the economies scales in production and exchange, cities also
attract economic activity because of agglomeration economies
Agglomeration economies is a term used to denote cost advantages enjoyed by a firm simply
because other firms are located in the vicinity
Types of agglomeration
1. Localisation economies: Within industry
● Cost advantages accrue to all firms operating in an industry
○ So an increase in the size of an industry in a city leads to an increase in
productivity of a particular economic activity in the city
■ Known as intra-industry external economies
■ Eg: Silicon Valley & One North (Innovation), Macau (Gambling), Wall
Street (Financial)
○ Benefits
■ Easy to hire right workers in the area with a large concentration of skilled
workers
2. Urbanisation economies: Across industries
● Cost advantages that the size of the city leads to an increase in a firm's productivity,
regardless of the size of the industry in which the firm is. Firms will benefit from the
concentration of different industries in a city
○ Benefits
■ Lower unemployment rate if workers are willing and able to change
industries
■
●
Roads, buildings and power supply benefit firms in cities regardless of
their industry
○ Eg: Inter-industry external economies
○ New York City or Singapore
Transnational urban agglomeration economy
○ One belt one road
■ Development strategy that aims to build connectivity and co-operation
across six main economic corridors encompassing China and countries
such as Mongolia, Russia, Pakistan
○ Blue Banana: Comprises ‘Greater London, The Dutch Randstand region;
Rotterdam; Swiss Basel-Zurich
Overall, agglomeration economies give firms an incentive to locate in large metropolitan areas
even though the cost of land and labour is higher in cities
Positive externalities of urban agglomeration
1. Sharing Of Intermediate Inputs
● Intermediate inputs is something produced by one firm as output and used by a second
firm as an input to the production process
● They will cluster to one another to share a supplier of intermediate inputs if 2 conditions
are met
○ Economies of Scale: Economies of scale in the input are large relative to the
demand for the input, and thus lowering the cost of input
○ Face to face: Intermediate input is not a standardised input which can be ordered
online, which requires physical interaction to ensure input is suited to the final
product
● Example of the cluster to share intermediate inputs
○ Movie production concentrated in the area in and around Hollywood. It is home
to seven major studios and hundreds of independent movie producers. One of the
intermediate inputs shared by movie producers is props. Eg, vintage cars, elf ear
tips, table lamps etc. In order to exploit economies of scale in supplying props,
movie producers share firms known as ‘prop houses’
○ In addition, this one cannot be done remotely as they will need to visit the prop
place physically to choose the most suitable prop for their movies
2. Tapping a common labour pool
● Big cities provide a source of trained and skilled workers that can be utilised at a central
point for assignment
● The role of labour pool
○ Workers move from declining firms to rising firms
■ Clusters facilitate the transfer of workers by lowering their search and
relocation cost to find a better-paid job. For example, transferring workers
from unsuccessful firms to successful firms.
○ The demand for labour per firm varies over time.
■ Firm clusters help firm to understand how quickly it can secure qualified
candidates and have them adequately trained to operate the new facility
● Benefit
○ Lower search Cost
■ Cluster has a higher density of information about job opportunities as
frequent interactions with friends in the same area generate information
about job openings. Hence, job applicants in a cluster spends less time
travelling from one employer to the next
○ Lower relocation cost
■ Worker switches to a nearby firm can avoid the cost of a change in
residence
3. Labour Matching (Skills Matching)
● Firms have different requirements on labours’ skill set, and there are variations in labours’
skill set
○ Large city can improve the matching of workers and firms, decreasing training
costs and labour costs. Because the increase in the number of workers in the large
city improves skills matching and thus decreases training cost
■ Doubling the size of the labour market is estimated to increase the
probability that a new hire by 0.5%, provided there is no a change of
industry while decreasing travel time to the new job by 5.8%
● Key assumptions of labour matching
○ variation in worker skills
○ economies of scale in production
○ firm skills requirements
○ training cost
● Calculation
○ Average skills mismatch is calculated as
1
○ m = 2(𝑛−1) , as n increases, the skills mismatch decreases, and thus decreasing
training cost
■ The formula illustrates the agglomeration economies associated with the
improved match of workers and firms as a city workforce grows.
○
4. Human Capital & Sharing Knowledge
● Human Capital
○ It is knowledge and skills acquired by workers in formal education, work
experience and social interaction. It can be increased through learning by
imitation - observing other workers and imitating the most productive workers.
Human capital is the economic value of an employee’s set of skills and qualities of
labour that influence productivity
○ To policymakers, human capital is the capcity of the population to drive economic
growth
○ Include
■ Tacit knowledge acquired through experience, non-cognitive skills such as
●
interpersonal skills, and the physical, emotional and mental health of
individuals
Knowledge spillovers (Sharing knowledge)
○ Positive working environment where good work is appreciated; inventions and
improvements in machinery. If one man starts a new idea, it is taken up by others
and combined with suggestions of their own; and thus it becomes the source of
new ideas
○ Exchange of ideas among individuals, through the channels such as
■ Localisation economies: Silicon Valley or One-North
■ Collective growth associated with R&D
■ Labour mobility through immigrant employees
■ Impacts between peers, clients or supplier
○ Sharing of knowledge provides an incentive for firms to cluster because
innovation leads to lower costs and higher profit.
■ (Glaser and Gottlieb, 2009) state that cities speed the flow of idea
■ Carlton and Kerr, 2015) states knowledge spillovers cause firms to cluster
and increase the number of firms (firm births) and total employment. It
also draws few conclusions
● Largest knowledge spillovers occur in the most innovative
industries.
● Knowledge spillovers are highly localised
● They are prevalent in industries with small, competitive firms
○ Example: Mindtree, IT company. The company's interior layout encourages
employees to mingle. Also, One-North in Singapore is also planned and designed
to create a ‘Work-live-play-learn’ environment. The idea is to bring a vibrant
community that sparks new ideas
Conclusion
Urbanisation, and localisation economies are important determinants of outputs in various
industries, countries and times. Agglomeration economies incentivise firms to locate in large
metropolitan areas even though the cost of land and labour is higher in cities.
Negative externalities of urban agglomeration
●
Clustering of firms increase total employment, generating agglomeration diseconomies
that partly offset benefits of agglomeration economies
○ Increase the size of the workforce and thus increase wage and production cost
○ Partly the forces behind the formation/size of an urban cluster
Equilibrium size of a cluster
Equilibrium size of a cluster
1. Location quotient
●
Location quotient measures a city's degree of localisation agglomeration.
○ Helpful in identifying industries in which localisation economies may be present.
For example, if 15% of a city’s employment is in industry i, compared with 10% for
the entire country, the location quotient is 1.5.
■ Means high location quotients - implies that a city specialises in an
industry, which in turn implies that localisation economies may be
present
● Alternative
○ Production function can identify firms in an industry that are subject to internal
economies of scale, localisation economies, or urbanisation economies.
○ It is more direct and insightful but is more data-intensive than the location
quotient approach.
2. Equilibrium size of a cluster: Corporate cluster
● Corporate cluster shares information vital to corporate decisions. Allow them to outsource
accounting and legal services to accounting firms. Exploit scale economies in providing
intermediate goods
● Why corporate locate HQ in Singapore: Half of Asia regional HQs located in Singapore
○
To explore agglomeration economies that cross industry boundaries ‘Urbanisation Agglomeration’ by forming ‘Corporate Cluster’
■ Singapore stands out as a preferred location for an APAC regional HQ
primarily due to the country’s strategic location, highly qualified human
capital pool, efficient business and stable political environment, strong
financial infrastructure, extensive participant network, and an effective
legal, regulatory and tax framework. Singapore’s easy access to a highly
skilled multinational workforce, significant and fast-growing APAC
markets, a pool of reliable and cheap labour sourced from neighbouring
countries, and well-established logistics infrastructure can facilitate MNCs
in achieving the substance required for the principal’s role, which is
especially critical in the post-Base Erosion and Profit Shifting (BEPS) world.
○ But how do they exploit the benefits of agglomeration?
■ Corporate cluster: Some firms specialise in providing information vital to
corporate decisions
a. Outsource to accounting and legal services
b. Exploit to scale economies in providing intermediate
goods
3. Equilibrium Size for a cluster/city
● Specialised cities
○ Larger cities become more specialised in managerial function, and small cities
are in production. Urban specificities in functions lead to different levels of
quality of life, industrial diversity and different kind of social conflicts, which shift
up and down the benefits and costs linked to pure physical size, leading to
different equilibrium sizes for cities
■ Each city operates on its own cost and production curves, defining a
specific optimal size
● Diversified (or Nursery) cities
○ High level of urbanisation agglomeration > diversified to foster ideas and
experiment
■ Suggest broad base of all industries > provide a nurturing environment for
early product design and development. Hence, foster new ideas and
experimentation, so they serve as nurseries for innovative firms
○ An innovative new firm may be incubated in a nursery city, then relocated to a
specialised city
● Advantages and disadvantages of specialised and diversified cities
○ Specialisation
■ Advantages are less urban crowding and stronger localisation economies
arising from the proximity of closely related producers. But disadvantages
are less innovation and more exposure to risk as the fortunes of specific
sectors and technologies rise or fall. So need to limit the risk of urban
specialisation, but limiting it may forego important present benefits to
avoid a possible future downturn.
○ Diversity/Nursery
■ The benefit of being a diverse city is that city with a wider range of local
sectors using different processes allows firms producing new products to
try more processes in search of their ideal one without incurring
relocation costs. At the same time, this could allow the city to discover
their comparative advantage and thus specialise in a certain type of good
or service.
● Summary
○
○
Specialisation in cities is partly the result of economic interactions within a given
sector (localisation economies), whereas diversity in cities is fostered by
economic interactions across sectors (urbanisation economies)
Ev: Although there is a positive correlation between the city size and the relative
diversity city index, which implies the larger cities are more diversified. However,
there is more to it than that. There are cases of specialised large cities such as Los
Angeles, which specialises in entertainment, and New York City specialises in
business and financial services. At the same time, smaller cities such as
Columbus and Portland are diversified.
Role of transportation in agglomeration
Economies of agglomeration represents industrial activities taking advantage of increased
interactions when they locate in proximity, also known as economies of agglomeration. This leads
to the setting of manufacturing clusters where transportation and coordination costs are lower
Hence, the transportation network leads to factor mobility and economic growth of the urban
agglomeration
Lecture 4: Where do cities and firms locate?
Location of cities
3 perspectives which explain the location of cities
Natural Endowment (First Nature)
● Nature endowment is the suitability of a place for producing certain products or trading
○ Mining cities > locate close to mining > role of railway is important
○ Port cities > built around a port > role of transportation is important
○ Inland cities > built from a big market area > role of river and canals is important
● However, natural endowment is important but not the dominant factor
○ Singapore
Path Dependence (Second Nature)
● It is a phenomenon whereby history matters; what has occurred in the past persists
because of resistance to change
● However, the city must adopt the right policies and thus make the city could transform
itself at the right. Singapore has successfully transferred from manufacturing-based to
financial and healthcare based.
Agglomeration Economies (Economic Forces)
●
This provides an explanation of city location driven by market force
○ leads to spatial economic activity clustering because of a variety of external
○
○
○
benefits
■ labour pooling, sharing of suppliers, specialisation, knowledge spillover
Alfred Marshall argues that the most important reason why people and firms
agglomerate is the reduction in transport costs. They can lower the transportation
costs of moving goods, people and ideas by clustering in an area
Agglomeration contributes to increased productivity and economic growth. But
there are external costs (diseconomy), such as traffic jams, pollution, and high
housing cost.
Nevertheless, if external benefits are greater than external costs, agglomeration
will lead the growth of cluster by attracting more workers and firms, contributing
to the formation of a city in a location.
Intercity location choices of firms
Firms and people choose their production location through agglomeration to reduce transport
costs by lowering the cost of moving goods and facilitating knowledge sharing.
Transportation-intensive firms
●
Resource-oriented firms: If inputs are perishable, locate a factory near inputs
○ Eg: Dairy products near cattle farms. Wineries near the grape farms
○ The outcome of the locational tug of war is determined by the monetary weights
of the firm’s inputs and outputs.
■ Monetary Weight = Physical Weight of the input * Transport Cost
■ Firm is resource-oriented because the monetary weight of its
transportable input exceeds the monetary weight of its output
○ Graph
■ Variable X measures the distance from the factory to the output market
in a city
● If the forest is 10km from the output market, the distance from
the factory to the forest is 10-x.
● Because the factory will be at the central location between
forest (input source) and output
■ Output cost is zero at the market and increases at the rate of the
monetary weight of the output. If at the forest (input market), the output
transport is $20
■ Total transport cost is the sum of input and output transport costs
● Total transport cost is minimised at the forest site at $20. Hence,
from any location, 1 km toward the forest (input market) would
decrease input cost by the monetary weight of input and increase
the output transport cost by the monetary weight of the output.
● The total cost is minimised when located nearer to the input
market because the monetary weight of input exceeds the
monetary weight of the output
■ Some resource-oriented firms locate close to the input market because
inputs are heavy or they are costly to transport (For eg, If the input is
perishable, and may need more expensive truck to transport as compared
to regualr truck
○ Overall, the firm will locate near its input source (Farm or Forest) as long as if it is
more expensive to ship if they are bulky, perishable, fragile, or hazardous than the
output
●
Market oriented firms: If the outputs cause high cost of transportation to the market,
locate factory near market
○ Beverage industry near bottle factory cause those are heavy to transport
○ Monetary weight of the output exceeds the monetary weight of the input, and
thus the market oriented firm will locate the factory near its market
○ Graph
■ Market oriented firm’s transport cost is minimised at the market
■ 1 Km away from the market increases the output transport cost by more
than it decreases input transport cost
■ Firms are market oriented if the output is more expensive to transport if
they are bulky, perishable, fragile or hazardous
■
Knowledge intensive firms
High tech firms make location choice different from traditional firms, often in a city with centres
of research and science where they can get a good chance of rapid market penetration by tapping
on the pool of high skilled labour
Other factors affect location choice
1. Labour cost
a. Labour is a local input because it is impractical for workers to commute outside of
metropolitan areas
b. Long run elasticity of business activity with respect to urban wage is elastic.
2. Energy technology
a. Although energy is not necessarily a local input now due to the development of
electricity that changed the location patterns of factories. But the availability of
cheap energy is still an important location factor to many firms. Eg: data centres
locate near Senoko power station in woodlands
Principle of Median Location
●
●
●
The solution to a firm’s location choice is the outcome of a multidimensional tug of war.
Among the forces, pulling a firm in one or more directions is low transportation costs
For firms that have multiple inputs or markets will have a median location that minimises
total travel cost/distance
Two conditions/assumptions
○ Delivery costs must be a linear function of distance
○ The customers must receive equal quantities of the manufacturer’s product
■ Take note: When these conditions are not met, the principle of median
location must be replaced by a more general location principle, but
subject to the same condition of minimising the total travel cost/distance
○ Under following the 2 assumptions/conditions, the objective is to minimise the
total travel distance
■ All inputs are ubiquitous > available at all locations for the same price, so
the cost of transporting inputs cost is zero
■ The price of repair service is fixed, and Fixit visits each factory once per
week
■ Each repair trip to a factory requires a separate trip, dont count return
trip
●
●
●
Graph
○ There are two factories in city A, eight factories in city B, one factory in city M, one
factory in city C, and nine factories in city D. Cities A, B, M, and C are 20 miles
apart, and city D is 100 miles from city C.
○ Fixit will minimize the total travel distance by locating in city M, the median
location. City M is the median because there are 10 customers to the west (in cities
A and B) and 10 customers to the east (in cities C and D).
○ Benefit of median location
■ To show the superiority of the median location, suppose Fixit starts in city
M, and then moves 20 miles east to city C. The move reduces the travel
distance to factories to the east (in cities
C and D) by 200 miles (10 factories times 20 miles) but increases the travel
distance to factories to the west (in cities A, B, and M) by 220 miles (11
factories times 20 miles). The total travel distance increases because Fixit
moves closer to 10 factories but farther from 11. In general, any move
away from the median location will increase travel distances for most
factories, so the total travel distance increases.
■ It is important to note that the distance between the consumers is
irrelevant to the firm’s location choice. For example, if city D were located
300 miles from city A instead of 100 miles, the median location would still
be city M. Fixit’s total travel distance would still be minimised (at a higher
level) in city M.
Why large cities become larger
○ Concentration of demand in large cities cause large cities to grow
○
●
○
Why industrial firms locate at transhipment points such as ports
○ A transhipment is defined as a place where good is transferred from trucks to
trains to ships
○ The location of the firms in port cities mean host both shipping firms and
manufacturing firms
○
○
○
○
○
Lecture 5: Big cities and Small cities
Formation of consumer cities
Principle of monopolistic competition
● Long run economic profit is zero
● This can be applied to a spatial context
○
●
●
If a single profitable Italian restaurant locates in the city centre, this attracts a
second Italian restaurant opens in the Northern area of the city because second
restaurant doesn't want to share the profit with the first restaurant in the city centre.
To save on transportation, people living in the north switch to the 2nd restaurant
○ As a result, the first restaurant makes less profit now. But, as long as the existing
restaurants make positive economic profits, new restaurants will continue to join the
competition till all make zero economic profit. Therefore. more and more restaurants
will join and be differentiated by the locations and access only
○ Overall, the city would have dozens of Italian restaurants, with each making enough
money to stay in business but not enough to trigger entry by other firms.
Key implication: Larger city can support more Italian restaurants as more people may
need them due to higher population > principle of monopolistic competition
Therefore, this shows us why a consumer city has to be a large city because only a large
city has a more diverse demographic and a large population to support a range of diverse
goods and services
Characteristics of consumer cities
● Cities as entertainment machinese
○ As consumer cities have to be a larger city
■ A larger city can also support a more variety of goods and services,
attracting consumers in search of a favourable mix of goods and services >
as a result, consumer interests tend to make large cities larger.
● Because the presence of large workforce and thus consumers in
large cities attract museums, theaters. These firms (opera house,
theaters, museums) provide consumer goods and services which
can only survive in large cities due to high set up cost.
○ Cities with large number of live performance venues grew faster. Also, positive
correlation between population growth and the number of restaurants per capita.
But, negative correlation between population growth and movie theaters and
bowling alleys.
● Fixed set-up cost
○ There is a fixed set-up cost (lease a place, renovation) > which are costs that could
not change in the short run, and thus there is a minimum market size required to
support a firm
■ High set up cost implies high market size > explains why high set up cost
requires EOS
■
●
k= fixed set up cost; q=quantity; c=variable cost
■
○
○
● d(p) = demand per capita, N = population size
High set up cost indicates high market size as shown in the formula
Conclusion
■ High set up cost and large economy of scale (resultant of high market
size) > need a large market demand to support the firm. Hence, market
demand has to be sufficiently high. Either demand per capita or N must
be large
■
●
Low set up cost and small economy of scale (resultant of low market
size) > don't need the large market size to support the firm, and thus
regardless of the market demand. So demand per capita or N does not
have to be large
Harvard Research Findings
○ High amenities cities are the precondition for consumer cities which attract consumers which leads
to high growth
○
In the past, the common perception of migration is because of employment opportunities. But the
Harvard research findings prove that high amenity cities attract population, so people do move to
the city for consumption
○
Hence, despite high rental, the people still choose to move to the city, which implies that they move
to the city for consumption
○
Conclusion: High amenity cities > high growth > urban rent goes up faster than
wage > implying people move to the city for consumption. Thus, urban density
facilitates consumption
Why are consumer cities important
● Play a significant role in the economy by creating jobs, generating income and promoting
economic growth
● Consumer cities are characterised by a high concentration of consumer-oriented
businesses such as retail stores, restaurants, and entertainment venues, which cater to the
needs and preferences of residents and tourists
● These group of tourists will further create inbound demand, and generates revenue for
local businesses. The influx of tourists can lead to developing other industries, such as
hospitality, transportation, and tourism.
Urban Hierarchy
Role of big cities
1. Concept of urban primacy
● Refers to a situation in which a single city dominates the urban hierarchy of a country or a
region to an excessive extent
○ Measurement of urban primacy
■ Largest city is over twice as large as the next largest city
■ Largest city is at least 3 times larget than the next two cities combined
●
2. Determinants of urban primacy
● Apart from size and economic influence, a primate city will have precedence in all aspects
of its country’s society, such as being a center of politics, media, culture and education
and receive the most internal migration
○ Economic hub: Trading, industrial agglomeration
○ Political hub
●
○
●
The evidence suggest political factors may lead to urban concentration
■ Trade and commerce
● High tariffs: means imported goods are heavily taxed > become exp
for local > the 2 outcomes are the switch to local goods and country
import fewer goods. Hence, increased internal trade with a low level
of international trade increases the degree of concentration
● Local producers produce more and need to employ more labour >
causing the city to be bigger
■ Politics in terms of the degree of instability
● The contestants will move to cities that are closer to the government
agency. The agenda of this is to show their political influence, which
constitute a great threat to the government, and thus makes the city
bigger and determines urban primacy
● Instability create urban concentration and weak governments may
not be willing or unable to protect life and property outside of the
capital in time of crisis
●
Distinguish primate city from mega city
○ A primate city refers to a city that dominates a country or region in terms of
population, economic activity, and political power, to a much greater extent than
any other city in the same country or region. The primate city typically has a
population that is much larger than the second-largest city, and it is often the
center of economic and cultural activity in the country or region. Examples of
primate cities include Paris in France, Bangkok in Thailand, and Lima in Peru.
○ On the other hand, a mega-city is a term used to describe a very large and densely
populated urban area, typically with a population of over 10 million people.
Mega-cities are often characterized by high levels of economic activity, cultural
diversity, and social and environmental challenges such as traffic congestion, air
pollution, and housing affordability. Examples of mega-cities include Tokyo in
Japan, Shanghai in China, and Mumbai in India.
○ While a primate city is defined in relation to other cities within a country or
region, a mega-city is defined by its population size and density. A primate city can
be a mega-city, but not all mega-cities are primate cities. For example, New York
City is a mega-city with a population of over 8 million people, but it is not a
primate city because it does not dominate the United States to the same extent as
Paris dominates France or Bangkok dominates Thailand
Role of small & big cities
● Big cities play a role in driving economic growth: production cities, trade cities; consumer
city; nursery city; primate city
● Small cities play important role
○ Can build complementary sectoral strengths by carving out roles providing
support or specialist function for a business located in nearby large urban centres
1. Core-periphery relationships: Building local economic reliance. Eg, Silicon
Valley in California is a core area in which the majority of the high-tech
firms are clustered
2. Play complementary roles within an urban hierarchy: maximsing benefits
of local assets
3. Connectivity: Many jobs held in the core area were contributed by
commuters from outside the local authority area.
a. If you want to grow, connectivity with the bigger cities is important
Eg: One belt One Road initiative (Good e.g. for connectivity) Speed
train in China > the effect is that lots of small towns and cities benefit
from the speed train in China. As the accessibility to these areas are
much more convenient. Economic research has proven that the
towns along those speed train track benefit from economic boom
Cost
The approaches of city-size distribution
1. Central Place Theory
● Provides a framework to explore the development of consumer cities in a regional
economy
● CPT is based on regional perspective and addresses two questions
○ How many cities will develop
○ How do cities vary in size and in the variety of consumer goods
● CPT predicts hierarchical system of cities in the regional economy
○ At the top of the hierarchy are large cities that have a complete set of goods and
services. As we move down through the hierarchy, cities become progressively
smaller and provide fewer goods and services
○ Can get anything you want in a large city, but not in a small city
● Assumptions
○ Fixed population
○ Ubiquitous inputs: All inputs are available at all locations in a region at the same
price
○ Uniform demand: For each product, the per-capita demand is the same at all
locations within the region
○ Perfect substitutes: For a given good, the products made by different firms are
perfect substitutes. There are no advantages from comparison shopping and, thus
no advantages from the clustering of firms selling the same product.
○ No Complementarity between goods: Different goods are not complementary, so
there are no advantages from the clustering of firms selling different goods
● Fixed population and ubiquitous inputs are essential to the model
●
○
●
●
High per capita demand relative to economies of scale > so can survive with small
population
○ Low per capita demand relative to economies of scale > so can only survive with
large population
The focus attention of this model is on the location choices of market-oriented firms,
defined as firms that base their location decision on access to consumers
○ Because the firms will choose locations that minimises the distances to their
customers > choose median location, which depends on the per capita demand
relative to economies of scale
Graph
○ 1 Clothing store: The per-capita demand is small relative to economies of scale >
So it chooses the median location, which is the city center because the population
density is uniform. Since the clothing store employs workers who live nearby, the
location of the clothing store increases population density in the area around the
clothing store. This is seen that the tallest bar is at center region
○ 4 grocery stores: They will divide the region into 4 equal market areas, but since
the density is higher in the city centered on the location of the clothing store,
○
○
there will be sufficient demand to support more than 1 grocery store, and thus
there will be 2 grocery stores at the city centre. Then the two remaining grocery
stores are for the rest of the region, this is shown that the 2 grocery stores split
the rest of the region into two equal market areas, and each locates at the median
location of its market area. Grocery workers will live near the stores, causing the
development of 2 additional cities, as shown by the mid sized bars at the 2 end.
16 barbers: Some will locate in the cities where population density is relatively
high, and some will divide the remainder of the region into small market areas
with populations of 3000 people. Assume, big city is large enough to support 4
barbers, each of the two-medium sized cities are large enough to support two
barbers. This leaves 8 barbers for the rest of the region, causing the development
of 8 more cities
The region has a total 11 cities that different in size and the variety of consumer
goods. This graph shows that city is large because it has a wide variety of goods,
and home to people who work in clothing stores, grocery stores, and barber
shops. On the extreme, those small cities only have barbershops and the mid size
cities has barbers and grocery but no clothing stores
○
Insights from Central Place Theory
Relaxing assumptions of central place theory
1. First Assumption
a.
2. Second assumption
a.
A key assumption of simple central place model is that per-capita demand does not vary with city
size. As city size varies with the variety of goods and services that you provide and thus larger cities
provid a wider variety of goods and services.
2. Spatial equilibrium approach
● Framework
○ Cities in regional economy are linked through the labour market. In the long run,
labours are perfectly mobile, moving from low worker’s utility city to high
worker’s utility
○ Nash equilibrium: workers will be indifferent between cities in a regional economy
when urban utility levels are equalised across all locations
● Model: Utility Curve
○ Upward pressure on worker’s utility
■ Increase in total employment generates agglomeration economies in
production and consumption that provide upward pressure on work utility
● Production: Benefits of agglomeration in economies such as share
suppliers of intermediate inputs, tap common labor pools,
improve skills matching will increase the workforce and thus
increase labour productivity and wages and thus increase worker
utility
● Consumption: Increase in population increases the variety of
consumer goods, which increases consumer utility
○ Downward pressure on worker’s utility
■ Agglomeration diseconomies provide downward pressure on worker
utility
● Commuting and house cost
● Disease
● Pollution
○
■
○
Before i, agglomeration economies in production & consumption >
agglomeration diseconomies. Vice versa after i
3 cases of regional equilibrium
■
Case 1 - Cities are not too small: Unstable, Self-reinforcing
● 6 cities configuration
●
●
●
●
■
Summary of case 1: When migration occurs (workers shift from
one city to another city). The shrinking city will move downwards
along the utility curve while the expanding city will move upward
along the utility curve. As such process continues, the utility gap
grows, and the shrinking city will eventually disappear while the
expanding city will double and its utility will reach the prime.
Hence, the expansion of one city at the expense of other city is
known as self-reinforcing. Migration is self-reinforcing if cities that
positioned on the positive sloped portion. A small random
deviation will ultimately eliminates the small cities that
experience random out-migration, so unstable. Hence, some small
cities disappear while some cities grow and experience labour
influx, and become big cities. Hence, self-reinforcing migration
ultimately eliminates the small cities that experience random out
migration.
● Also, in order to determine whether a city is small, we look at
whether the workforce is less than utility-maximising workforce.
The core of this case 1 is that cities will never be too small
Case 2 : Cities may be too large - Stable: Self-correcting
● 2 city configuration (A&B) ● Imagine both cities are at point j, suppose some workers from city
B move to city A. Thus, City A has grown and move downward
along utility curve from j to g, and utility level fall below u’’. While
the city B has shrunk and moves upward along the utility curve
from j to s, and so the utility increases to a level above u’’. In this
case, utility is higher in small city (B) now. So the workers will
reverse the earlier moves: A will now shrink and B will expand,
and the migration will continue until each city returns to original
workforce of 6 million and original utility u’’.
●
■
●
Case 3: Efficient Cities
● 3 city configuration (A&B&C)
●
●
Hence, the stability of the efficient configuration is determined by
the slope of the utility curve around its peak
○ Stability: If the utility curve is steeper to the right of the
peak than it is to the left of the peak, then the decrease in
utility triggered by in-migration (A) is larger than the
decrease in utility from out-migration (B), so utility in the
growing city (A) is less than the utility in the shrinking
city (B). Thus migrants will regret and move back, and
this is self-correcting.
○ Instability: If the utility curve is flatter to the right of the
peak than it is to the left of the peak, then the decrease in
utility triggered by in-migration (A) is smaller than the
decrease in utility triggered by out-migration (B). Hence,
the growing city has higher utility than the shrinking city.
Such migration is self-reinforcing, and as a result the
growing city continues to grow and the shrinking city
continues to shrink (show that A is growing at the
expense of B). **** For the case of instability, it is difficult
to predict the ultimate outcome in terms of the size and
number of cities. The outcome is unpredictable unless we
know more about the slope and position of the utility
curve.
○
Differences in city size
■
■
Rank Size Rule
Lecture 6: Some cities grow while some cities decline /
Urban Economic Growth
Urban Economic Growth
Definition
Economic Growth is defined as an increase in per-capita income
Unlike Economic Growth definition, urban economic growth is defined as an increase in the utility
level of resident.
Hence, urban definition accounts for factors other than wage, include benefits such as product
variety, and cost of urban living (housing cost, commuting cost, pollution)
Factors lead to economic growth of city
1. Capital deepening
●
●
●
In economics, use of capital can increase work productivity
Capital deepening refers to capital-labour ratio: Such ratio increases either due to an
increase in the capital stock/quality or through decrease in the number of workers due to
increase in labour productivity
○ Hence, increase in capital-labour ratio increases worker’s productivity and income
○
●
2. Increases in human capital
● Human capital includes the knowledge and skills acquired through education and
●
experience. An increase in human capital increases productivity and income
Effects of increase in the education or job skills
○ Higher wage: Worker’s productivity increases and competition among employers
to increase wage to match the worker’s productivity
○ Spillover benefits: Workers learn from one another by sharing knowledge in both
formula and informal settings > workers with more human capital has more
knowledge to share
○ Technological progress: Increase in human capital leads to an increase in the rate
of tehchnolocial innovation, which increases productivity and income
○
○
■
(Moretti, 2004): wage of high school dropouts increase higher than high
school graduates & college gradutes because the utility curve for high
school dropouts experiences the highest increase
■ Foreign investment and human capital investments are complementary
inputs
3. Technological progress
● Efficient production and invention of faster microprocessor are all considered as
technological progress > increase in productivity leads to increase income per worker
4. Agglomeration economies
●
Relationship between technological progress/innovation & Regionwide Utility
●
●
●
●
●
●
New equilibrium is shown by point c and d. This is also known as locational equilibrium
because;
○ Two cities have same utility level, u**
○ Workforces in the two cities add up to the fixed regional workforce
The innovative city (point d) gains 1 million workers while the non-innvoative city (point
c) loses 1 million workers. But both cities utility increases from original (u*) to (u**)
meaning that workers in both cities benefit from innovation in one city.
○ Workers in the other city benefit because the decrease in population causes the
city to move upward along its negatively sloped utility curve from (point a) to
(point c) where u** > u*
Hence, the benefits of technological progress in one city spread to other cities in the
region. Thus, any initial gap utility will be eliminated by labour migration to the city with
the higher utility level, and migration will continue until the utility gap is eliminated.
○ The new increase (u** - u*) is roughly half of initial utility gap (u’’ - u*) because 2
cities share the benefits of innovation
However, in a larger region, the increase in utility would be smaller. If the region had 10
cities instead of 2, there would be 5 times as many workers to share the benefits of the
innovation. Thus, the increase in utility would be about 1/10 rather than ½ the initial
utility gap. Similarly, if the region had 50 cities, the increase in utility would be roughly
1/50 of the initial gap.
○ Overall, the larger the number of workers over which to spread the benefits of
innovation, the smaller the benefits per worker.
Conclusion of the relationship between technological progress/innovation & Regionwide Utility
●
○
○
No utility gap if both cities experience the same increase in productivity. Because
both experience the same upward shift of the utility curve. Hence, there will be
no utility gap to overcome with migration
The same relationship between utility and technological progress applies to these
factors as well: Capital deepening, increases in human capital and agglomeration
economies
Why do some cities grow
●
●
●
Why some cities decline
●
●
●
Lecture 7: Why are people attracted to a city / The
Ubran Labor Market
Migration and city
Major urban events and total employment
● Impact of hosting Olympic events
○ Positive correlation between host of Olympics and international trade (more than
20% increase in the trade)
■ Signfalling effect: As Olympics Games are usually bid in advance (7-10
years ahead). Successful Bid allow the world to know that they want
become bigger international players > allow trade liberalsiation
■ Just announcing the Olympics has large effect: Expectations of higher
future expenditures encourages higher investment and consumption
○ Not necessarily always link to positive impacts
●
■
Why are cities willing to rely on professional sports events
○
○
○
○
However, but why are the employment effects of stadiums are relatively small?
■ A large fraction of sports fan live in the metropolitan area. For example,
only about 5-20% of fans at a typical MLB game are visitors from outside
the metropolitan areas.
● Therefore, most of the money spend on professional sports
events come at the expense of local goods such as movies and
restaurants meals. Because since the visitors are mainly local, and
thus this implies they are switching from movies and restaurants
to consuming foods while watching games at the Stadium. For
example, there may be more popcorn sold in the stadium but less
popcorn sold in movie theaters.
● As a result, when the visitors constitutes large proportion of local,
consumers are just switch from movies and other local goods to
sports events, and thus the employment effects of sports teams
will be relatively small.
3 Effects to explain why the economic effects of majors sports events are relatively
small
1. Local substitution: Some people spend money on sports events
that they would have spent elsewhere in the local economy. Even
the visitors may also spent large money on the sports events
instead of consumin other local products. Therefore, the
employment effects is relatively small.
2. Crowding Out: Hotels may be filled with football fans rather than
tourists
3. Leakage: Large fraction of the money spent on mega events goes
to people who live outside the metropolitan area. For example,
few athletes and coaches live in the host city, so most of the
money paid to athletes and coaches generates the multiplier
effect elsewhere.
Public Taxation policies and total employment
Effects on firm location decision
●
●
2 types of business location decisions - The elasticity of business activity with respect to
tax liabilities = percentage change in business activity / percentage change in tax liabilities
■ Interstate Decision (Between cities in different states or regison)
■ Intra-state Decision (A choice between sites within a state or region)
○ The elasticity for intrastate decision is larger because firms are more mobile
within states than between them (interstate decision). Hence, alternative
locations within a state are better substitutes than alternative locations in
different states
○
●
○
●
Hence, the elasticity of business activity with respect to tax liabilities for
manufacturers are more elastic
Importance of tax revenue and expenditure
○
Effect on urban employment
Why are people attracted to a city
Labour Supply
● Positive Sloped - Increase in the wage leads to increase in the quantity of labour supplied
(more income for the workers and so more people want to work)
○ 2 assumptions
■
○
Why is labour supply positively sloped? (formula)
■
■
○
Hence, the increase in the wage is in line with the increase in the cost of
living
Inverse of the elasticity of the wage with respect to the size of the workforce give
us labour supply elasticity
■
The city labour supply elasticity is larger than the national labour supply elasticity
because migration between cities is less costly than migration between nations
Factors that determine the shift in the labour supply curve
○
●
○
Labour Demand
● Negatively sloped - A decrease in the market wage increases the quantity of labour
demand (lower COP for firms > so want to hire more)
○ Input Substitution effect: Decrease in the wage cause firms to substitute
○ Output effect: Decrease in the wage decrease production costs, and firms
respond by cutting their prices. Consumers would purchase more cuz it is cheaper
and firms will respond to the increase in output by hiring more workers.
○ Agglomeration effect: More available of labour pool which leads to competitive
●
labour market. Hence, the presence of agglomeration adds third effect of a
decrease in the wage. Thus, the decrease in the wage and the resulting increase
in the quantity of labour demanded allows firm to exploit agglomeration
economies that increase labour productivity > decreases production cost and
prices, and thus firm produce more output and hire more workers.
Factors that determine the shift in the labour demand curve
○ Demand for exports: Increase in the demand for city’s exports > increase
production > shift demand curve to the right
○ Labour productivity: Increase in productivity > Lowers production costs > Allow
firms to cut prices, increases output, and thus hire more workers > shift demand
curve to the right
■ Labour productivity increases with capital deepening, technological
progress, increases in human capital, and agglomeration economies
○ Business taxes: Increase in taxes without a corresonponding change in public
services > increase production costs > increase price, decrease output and thus
decrease demand for labour
○ Industrial public services: Increase in the quality of industrial public services
without a corresponding increase in taxes > decrease production costs > increase
output and labour demand
○ Land-use policies:
■
Employment Multiplier
● Total employment in a city = Export employment + Local Employment
●
●
●
Export workers: workers who produce goods that are sold to people who live overseas
○ Another label is tradeable goods
Local workers: workers who produce goods that are sold to local residents
○ Another label: non-tradeable goods
○ We want to achieve more tradable goods because it can boost via multiplier effect
Relationship between export employment and local employment is determined by multiplier
process
○
○
How does an increase in the demand for export increase the overall laboour demand
with graph
■
■
■
●
●
■
126 - 100 = 26 (Total Employment)
110 - 100 = 10 (Export Employment)
Which changes the employment multiplier
1.
●
●
2.
●
Composition of the economy
Labour intensive sector > higher employment multiplier
Capital intensive sector > lower employment multiplier
Labour Market Conditions
High level of employment and underutilised labour resources > Larger pool of availabe
workers > Increase in demand for goods & services > larger increase in employment
● Low level of employment and underutilised labour resources > Smaller pool of available >
Increase in demand for g&S > smaller increase in employment
3. Import and Export Relationships
4. Government Policies and Interventions
● Promote development of labour intensive industries or support the growth of domestic
supply chains
5. Time Horizon
● ST: Increase in demand lead to immediate and direct increase in employment
● LT: Capital investment, technological changes and structure adjustment > Increase
employment in the long term
Why an initial increase in employment in the export sector cause employment in local sector to
increase
1. Supply Chain Effects
● Increase in demand for export goods > Export sector expands > Require more inputs from
the local sector to meet the increased demand > Increase demand for local goods such as
suppliers, manufacturer, service providers to meet the demand of the export sector
2. Induced Effects
● Increase demand for exports goods > Income for the export workers’ increase > Spend
more on local goods and services (Entertainment, Housing etc) > Increase employment in
the local sector that cater to the needs and preferences of the export sector workers
3. Technological Spillover Effects
● Export sectors required technological advancement > Spillover to the local sector >
Increase productivity and competitiveness > Increase demand for skilled workers in the
local sector
4. Knowledge and Skill Transfer Effects
● Export sector requires skilled workforce to meet the quality of the global market >
Increase in demand for export goods > Expansion in export sector > Provide opp for local
workers to acquire new knowledge, expertise through training programs > These skills are
transferable to the local sector > Lead to increased employment
Multiplier in small and large cities
Policy Implications of employment multiplier effect
●
●
●
Comparative Statics: Changes in demand and supply
● We aim to analyse
●
○
Case 1: Demand for export workers increase (Demand increase)
●
○
●
Demand for export workers increase by 10,000 > Due to multiplier process,
demand for local workers increases by 20,000 > Total demand for workers
increases by 30,000 > Since more people working, implies population increases >
Cost of living increases > Wage increases to compensate workers for higher cost of
living
We use 2 formulas to predict the effect of an increase in demand on city’s equilibrium
wage and employment
○ Formula for the change in the wage
■
> top is the horizontal shift of the
demand curve & es is wage elasticity of labour supply and ed is the wage
elasticity of labour demand (negative number)
■
●
Since total demand increases by 30% (130-100/100), demand
elasticity is -1.0 and supply elasticity is 5.0. The predicted change
in equilibrium wage is
○
●
○
Formula for the change in employment
■
○ Overall, an 30% increase in total demand leads to 5% increase in the equilibrium
wage and a 25% increase in equilibrium employment. In other words, the
employment multiplier is 2.50 because;
■ Initial increase in export employment of 10,000 jobs triggers multiplier
effects that increase total employment by 25,000 jobs
Case 2: Market effects of an increase in Labour Supply (Supply increases)
○
○
○
●
○
Case 3: Labour demand and supply both increase
○ Employment effects of local environmental policy: Pollution Tax. 2 industries: a
polluting steel industry and a clean industry. A pollution affects both sides of the
urban labour market
○
■
Tax increase cost of steel production > firms either pay tax or incur
abatement cost (equipment to detoxify toxic gases) > both increase COP >
steel producers by the increased cost to consumers in the form of higher
price > consumers purchase less steel and demand for steel fall > the
decrease in steep output and lead to an decrease in demand for labour >
fall in equilibrium wage and decrease the equilibrium quantity of labour
○
■
○
○
Pollution tax causes volume of pollution to fall > improvement of city’s air
quality > increases the relative attractiveness of the city > causing workers
to migrate to the cleaner city > increase in supply of labour > decrease
equilibrium wage and increase the equilibrium quantity of labour
Thus, a pollution tax shift both supply curve and demand curve > there will be
definite fall in the wage, but equilibrium quantity of labour and thus employment
could either increase or decrease
■ Increase equilibrium employment: Increase in supply > Decrease in
demand, due to reasons:
1. Increase in production cost caused by tax is relatively small
2. Demand for the export good is inelastic and thus the demand for
labour fall less than proportionately than increase in price
3. Improvement in environmental quality is relatively large
4. Workers are relatively sensitive to changes in environmental
quality
■ Decrease equilibrium employment: Decrease in demand > Increase in
supply
1. Increase in production cost triggered by the tax is relatively large
2. Demand for the export good is relatively elastic
3. Improvement in environmental quality is relatively small
4. Workers are relatively insensitive to changes in environmental
quality
However, for clean industry, the pollution tax may not lead to an increase in
production cost. As the direct effect (higher taxes and abatement cost) is at least
partly offset by a decrease in labour cost from the decrease in the city’s wage. For
clean industries, the decrease in labour cost outweigh, so production cost
decreases. Hence, the employment in clean industries increase at the expense of
employment in polluting industries.
■
Human Capital Externalities
Lecture 8: Urban Land Rent Structure
Land and economic rent
Definition
● Land is a factor of production. Other FOP are labour, capital and entrepreneurship
○ Land as a natural resource is not produced
● Income earned by landowner for supplying the land is rent
○ Economic rent is the income earned in excess of the cost of supplying the service
which gives us economic profit
○ Economic rent accrues to the factor input with inelastic supply
■ Because supply of land is inelastic so land often earns economic rent
(Land is not transportable; immobile)
● Income earned for other FOP
○ Labour: Wage
○ Capital: Interest
○ Entrepreneurship: Profit
Assumptions
● Perfect Competition: Farmers are price takers, and economic profit is zero in the long run.
● Price of non-land input such as material, labour, capital are the constant
○ More fertile land can produce a greater amount of crop with the same amount of
inputs (e.g. labour, seeds and water)
● Supply of farmers’ labour service and other inputs are elastic
○ Farmers’ wage rate would not depend on land’s fertility, since the supply of
farmers’ labour service is elastic.
● Land plots are allocated to highest bidders
● Zero shipping cost
● National Prices: All prices are determined in the national market and are unaffected by the
events in the region
Land Rent and Land Value
● Market Value / Price of the land
○ is the discounted present value of the rent cash flow that the plot is expected to
produce in the future
●
○
Land price depends not only on the present land use but also on the potential future land
uses
○ Redevelopment potential (But this is not the main focus)
Ricardo Model of Agricultural Land Rent
Basic Concepts
● Differential productive quality of land: fertility, intrinsic quality
● Price of land = Willingness to pay for agricultural land, which is determined by the profit
that can be earned on the land
● Farmining profitability depends on fertility of land
○ More fertitle land can produce a greater amount of crop with the same amount of
inputs (labour, seeds, and water) > you get more yield and profit
○ Farmers bid for land plots of different fertility owned by landlord
○ High profit accrues to the landowner in the form of higher bid rent
● Famers’ wage rate should not depend on land fertility. Because supply of farmers’ labour
service is elastic
Determine farmer’s profit on land that is highly fertile
●
●
○
●
○
●
Fig 10-2 shows that farmers on relatively less fertile land which produce the same
amount of corn as fig 10-1 but incured higher cost
Overall, the higher the fertility curve, the lower the cost curves. The cost curves in Fig
10-2 are higher than the cost curves in Fig 10-1, reflecting less fertile land and thus higher
production cost.
○ Given the fixed market price for corn, the higher cost means that profit
maximising quantity is lower, and thus the profit is lower.
The leftover principle
● Competitive bidding among farmers for fertile land drives up the land rent to which
farmers earn no economic profit. So the economic profit of farming is captured by
landowners. Thus, leftover principle is the highest bid rent for a plot of land that equals
to the economic profit of farming
○ Economic profit = Revenue - Non Land Cost
● Assumptions
○ Individual plot of land has different fertility, but they are homogeneous as they
have access to the same production technology and input prices.
○ No restrictions on market entry as supply of farmer’s labour is perfectly elastic
● Since equilibrium land rent due to competitive bidding makes economic profit equal to
zero, farmers are indifferent between different plots of land.
○ Although higher fertility land has lower production costs, the savings in
productions costs are exactly offset by higher land costs
● When leftover principle does not work
○
Improvement on Farmland
● Irrigation Project that increases corn farming productivity > increase supply
○ If the demand is perfectly elastic (horizontal demand curve)
■ Price unchanged, output increase. Economic Profit increase for the
improved plots but is unchanged for the unimproved plots
● Winner: Landlords of the improved plots receive higher bid rents
● Loser: Farmer and consumers receive no benefit as wage rate and
corn price are unaffected
○ If the demand is imperfectly elastic (elastic)
■ Price decreases but total revenue increases with quantity traded. So
economic profit of the improved plots will increase while the economic
profit of the unimproved plots will fall (because consumers will switch
from unimproved to improved plots due to the fall in the price)
● Winner: Landlords of improved plots benefit from higher
economic profit. Corn consumers benefit from lower prices
● Loser: The landlord of unimproved plots lose out
○ If the demand is inelastic
■ Price decreases and total revenue decreases with quantity traded. The
irrigation project will raise output but lower the economic profit for all
corn farm plots
● Winner: Corn consumers
● Loser: The landlord
Von Thunen Model of agricultural land use and land rent
Basic Concepts
● Differenetial location quality of land: Focus on proximity
○
●
●
Question we ask ourselves: How much a manufacturer is willing to pay for land at
different locations in a city?
○ In an urban environment, the willingness to pay for a plot of land depends on its
accessibility rather than its fertility.
○ In the market, land is allocated to the highest bidder, and so the land bid of the
manufacturers determines where manufacturing firms locate
■ Hence, this is why we see urban manufacturing employment is
decentralised and dispersed, with the most firms locating close to
highways connected to the intercity highway system. Hence, the price of
urban land increases with its accessibility
There is central market place where farmers ship all their output for sale
○ Economic profit decreases with increase distance from the market center due to
increasing shipping costs
The shipping rate varies by farm products
○ Perishable product are costly to ship (Milk and Vegetables) > highest shipping cost
○ Non-perishable product are less costly to ship, livestock has the lowest shipping
cost (Wood and Grain)
Bid-Rent Gradient
Freight Cost and Labour Cost
●
○
Moving farther away from the central freight terminal,
■ Freight Cost will increase
● Lowest at the central terminal
■ Labour Cost will decrease
● Highest at the central terminal
●
○
○
First Graph
■ The horizontal axis measures the distance to the central freight terminal.
The intermediate input cost is constant so it is straight line. Freight cost
increases linearly $10 per km. Labour cost is $40 at the center, and
decreases at $4 per km.
● Total cost increases from $50 at the center to $80 at a distance of
5km.
■ The slop of total cost curve is $6;
● Means that 1 unit increase in distance increases freight cost by
$10 and decreases labour cost by $4, for a net increase of $6
Second graph: Bid for land
■
●
●
●
Bid Rent Gradient
Total revenue is the same
At the central freight terminal, the bid is $42 = $92 (Revenue) $50 (Total Cost)
As the distance to terminal increases, the total cost increases at a
rate of $6 per km, so the bid rent decreases by $6 per km (since
total revenue is constant)
○ For example, the bid rent is $36 at a distance of 1km (92 (50+6), and $12 (92-50)-(6*5km) at a distance of 5km
●
Applying the leftover principle, a firm’s willingness to pay for land at location x equals total
revenue - non-land cost
○
○
○
Slope of the bid-rent curve curve
■
●
●
○
Bid-rent gradient determined by the per-acre shipping rate.
Farming activity with high shipping rate (greater bid-rent
gradient) has a comparative advantage occupying a more central
location. In equilibrium, farming activities sort into different
distance zones according to the bid rent gradient. Therefore, the
activity with the greatest gradient locates the most central zone
and the activity with the least gradient occupies the most
distant zone.
The graph shows bid-rent for milk / vegetables is the steepest as
the goods are perishable and thus high freight cost
Why is manufacturing bid-rent curve negatively sloped?
■ The model incorporates the transportation technology of the early 20th
century. The truck had not yet been invented so the intracity freight was
by horse cart, a slow and costly freight system. In addition, intercity
freight was by ship or train, so manufacturers were tired to a central port
or railroad terminal. While workers commuted on faster streetcars from
suburban residential areas to central core areas. Hence, freight cost (cost
○
of transporting inputs and outputs), represented by f, was high relative to
the cost of transporting workers, represented by c. Since f > c, the
manufacturing bid curve is negatively sloped, and will outbid other land
users.
Why is manufacturing bid-rent curve positively sloped?
■ Due to technological advancement, the innovation of truck reduce the
freight cost as it is faster and less costly to operate. Hence, the freight cost
curve becomes flatter, reflecting lower freight cost per km.
■ Since the total cost curve is now negatively sloped because as firm moves
away from the center and towards the suburban (where some workers
live), the savings in labor cost dominantes the increase in freight cost.
Therefore, the bid-rent curve is positively sloped
● To illustrate the positive slope, suppose the freight cost decrease
from $10 to $1. In this case, the slope of the bid rent curve i +$3
■
○
Since freight cost is low relative to the cost of transporting workers, a firm
will be willing to bid more for land farther from the freight terminal, and
closer to its suburban workforce
Exercise 1: Compute Bid Rent Function and Farming Zones
Farming Activity
Vegetable
Grain
Price at the market center
$50 per bushel
$24 per bushel
Shipping rate per bushel
$3 per mile per bushel
$1 per mile per bushel
Annual Farm Productivity
100 bushels per acre
150 bushels per acre
Annual non-land production
cost per acre
$2,000 per acre
$1,200 per acre
Bid-rent gradient (per-acre
shipping rate)
$3 x 100 = $300 per mile per
acre
$1 x 150 = $150 per mile per
acre
Bid-rent at the market center
(Zero-Shipping Distance)
$50 x 100 - $2000 = $3000 per
acre
$24 x $150 - $1,200 = $2,400
per acre
Which farming activity
occupies the central zone
Vegetable occupies
What is the outer Boundary Distance of the farming Zone?
● For the inner boundary, vegetable land use competes with grain land use. Thus the
boundary is determined by the equalization of the two bid-rent functions.
○ 3,000 - 300d = 2,400 - 150d
■ d = 600 / 150 = 4 miles
● The outer boundary is determined by the distance at which the economic profit of land
use becomes zero.
○ 2400 - 150d = 0
■ d = 2,400 / 150 = 16 miles
○
Exercise 2: What if the demand for vegetable increases? Assuming that the demand for grain is
perfectly elastic
●
Demand increases > Vegetable price increases > TR Increase > Higher demand for the land
> Bid rent curve function shift up > Vegetable farming zone expands > Inner boundary of
vegetable expand > Grain farming zone shrinks and thus grain supply falls
●
Monocentric City Model of Residential Land Use and Land Rent
Assumptions
1. All households commute to CBD to work
2. Residential location affects by the commuting cost, which increases with the distance to
CBD
3. Commuting cost is the same
4. 2 types of households
a. High-Income household, which consumes AH acre of residential land per
household
b. Low income household, which consumes AL acre of residential land per household
c. AH > AL : Why high income households consume more residential land per
household than low-income households
i.
Larger Housing: High income tend to have larger homes, which require
more land. Also need more outdoor space for landscaping, gardens.
Principle of compensating variation of bid rent
●
Household’s willingness to pay for its residential land varies by location to compensate for
the differential commuting costs
○ The sum of land cost and commuting cost is spatially invariant
○ In other words, the bid rent for residential land by high income household
■
○
■
■
■
1) Why are low-income household more competitive in the central
location residential land market
● Proximity to employment: Central locations offer proximity to
employment which may be attractive to low income household
who mainly rely on public transportation
● Savings on transportation costs: Living at the central location offer
savings on the transportation costs which could be a significant
amount to the low income household
2) What if the number of low income households in the city increase?
● Increase in the number of household will increase the bid rent
function so that the high density zone can expand outwards to
supply additional housing to low income households
● 3) How will the high-income bid rent function change also?/
○ High income bid rents will also increase to expand the
boundary
The outcome of these is that the real incomes of both low & high income
household decrease
○
■
■
■
Low income more competitive than higher income because low income
consumes less land than high-income, and thus is more competitive
If the low income pop increases, this indicates demand increases and thus
the low income bid rent curve goes up so that high density zone can
expand outwards to supply additional housing to low-income households
The high income bid rents will also increase to expand the urban
boundary
● But the real incomes of both low-income households and
high-income house holds decrease
Gentrification
●
●
Gentrification is a process in which neighbourhood experiences an influx of higher income
residents > causing change to the neighbourhood’s character
Gentrification often leads to displacement of low-income residents who can no longer
afford the rising costs of housing and other expenses associated with the changes in the
neighbourhood
○ Low-income are displaced from the central neighborhoods
○
○
Thus, they have to raise the bid rents in order to expand the high-density zone
outwards
Real income of low income households decrease
Monocentric City Model of Business and residential Land Use and Land Rent
Why is the central area of this monocentric city occupied by office firms rather than
manufacturing firms
● Office Bid Rent Curve
○ Due to more work hours worked by the skilled workers which lowers the
importance of residential space and increase the proximity to work
○ Agglomeration economies: the productivity of business firms increases with
proximity to other business firms due to the benefit of face-to-face interactions
○
○
Office district is the highest bidder
○
○
○
●
Office bid rent curve is steeper because the opportunity of travel for office
workers is higher. The manufacturing bid curve is flatter because the
opportunity cost of transporting the input and output is lower than the opp cost
of office workers. This is because the productivity of business firms increases with
proximity to other business firms due to the benefit of face to face interactions.
The production of the office sector involves information exchange, which requires
travel by workers from one firm to another. If one office firm moved from the city
center toward its suburban workforce would save on commuting cost and thus
pay a lower wage. But the firm’s workers would spend much more time traveling
to the other office firms near the city center. Hence, for office firm with relatively
high frequent interactions with other office firms, the total cost will be lower
near the city center. While manufacturing firms could move away from the city
center due to technological advancement which making shipping or transporting
much easier than before. Therefore, office firms would outbid manufacturing
firms for the most accessible locations.
Residential Bid Rent Curve
○ What causes the upward shift in the residential bid-rent curves
■ Reservation (Utility) decreases (assume on the negative slope)
■ Household income increases
○ What causes the change in the residential bid-rent gradient
■ Slope of the residential bid rent function is determined by the slope of
housing price
■ Slope of housing price is determined by commuting cost
■ Commuting cost increase > increase slope of housing price > Increase the
residential bid-rent gradient, i.e the slope of residential bid-rent gradient
get steeper (more expensive)
●
●
Open City vs Closed City
○ Open city: Free labour mobility > so utility depends on inter city competition
○ Closed city: No Inter city mobility > the local population is fixed > so utility
depends on the income
Urban utility curve & Residential Bid rent curve
○ Explain negative slope of the urban utility curve
■
■
■
When migration occurs > people move into more innovative city >
population increases (become denser) > utility decrease (suggest the city
in on the negative slope) > Bid rent curve shift up, and thus R1(0) > R0(0)
Gradient = t/A1 > t/A2, so land consumption per household decreases as
more people moving in so land rent increases
● Commuting cost increase > slope of housing price increase > Bid
rent for residential will increase, i.e become steeper >
Residential zone shrink > reservation utility decrease
● Overall effect
○ Increase population > Land consumption per household
decrease > Reservation utility decrease
Land market and labour market
● Assumptions
○ No consumer substitution or input substitution > population density is the same
at all residential locations, and employment density is the same at all business
locations
○ City is not circular, but rectangular with a fixed width of 10 km and a length
● Business land use is linked to labour demand. Residential land use is linked to labour
supply
●
○
○
●
●
Business bid curve intersects the residential curve at point a > generates 2 km CBD
■ Total demand for labour = Land Area of CBD * Employment Density
● 20km2 * 120,000 workers
Residential bid curve intersects the agricultural curve at point b > generates 4km
residential area from 2km to 6km
■ Total Supply of labour in the city = Land area of residential area *
Residential density
● 40km2 * 120,000 workers
○
While the right panel shows the urban labour market, with a negatively sloped demand
curve and a positively sloped supply curve
○ Negatively slopped labour demand curve: An increase in the wage increases
production costs (Fall in the profit firm make). Applying leftover principle, (fall in
the demand for land) the bid for business land decreases, so the biz territory
shrinks. Decrease in the business land size lowers the quantity for labour
demanded.
○ Positively slopped labour supply curve: Increase in the wage increases > increase
in household income > household’s willingness to pay for housing and housing
prices as workers can afford to travel to the office (Income increases for the
workers is like profit increase > Applying the leftover principle, an increase in
housing prices increases the bid for residential land, increase the territory of the
labour supply sector and thus increasing the quantity of labour supplied.
Case 1: What will happen in the urban land market and urban labour market if commuting
cost in the city decrease
○ Short-term effect of the street car: With respects to figure 14-3, the initial
equilibrium is shown by points a & b. As streetcar replaces walking as a
commuting mode so it decreases the unit commuting cost. Since street car
○
○
○
decreases the commuting cost, so decreases the slope of the housing price curve
and thus residential bid curve become flatter > residential bid rent gradient
decreases
Hence, the intersection of the residential bid rent curve and the agricultural bid
curve shifts from point b to point c (Figure 14-4), and the residential area grows
by shaded area (change R).
■ The expansion of the residential area causes excess supply of labour. The
excess supply of labour decreases the city wage, causing changes in the
business land market (increase quantity demanded for labour)
The long term effect of the street car
■ The excess supply decreases the city wage. According the leftover
principle, a decrease in the wage decrease production cost. Thus the high
competition among firm for land bids up the price of business land >
lead to expansion of business land
■ On the other side, the decrease in the wage > decrease the price of
housing (affordability to housing) > decrease the residential bid rent
function > shifting the residential bid rent function downward > the
residential zone will start shrinking > fall in labour supply again
● As fall in the wage indicates a lower willingness to pay for the rent
■ The general equilibrium is restored at points d and e. The streetcar
increase the size of the business district and residential district. (Fig 14-5)
■
The streetcar has a direct effect on the land market
■ Allow residents to outbid agricultural users for remotes land due to
lowering of commuting costs
○ The streetcar has an indirect effect on the labour market
■ The excess supply of labour decreases the wage > which in turn affects
the land market b changing the bids for land, triggering the changes in the
territories of firms and workers.
Case 2: What will happen in the urban land market and urban labour market if the labour
demand increase
○
●
○
○
○
Urban land market
■ Increase productivity > Increase labour demand > Business bid rent curve
shift up > increase in business zone
■ Increase labour demand > increase wage rates > increase household
income > increase housing price > increase residential bid rent curve >
increase in residential zone
■ Overall, the increase in labour demand leads to increase in both business
zone and residential zone to match increased employment and residents
Urban labour market
■ Wage increase > higher household income
■ Workers employed increase > higher employment rate
Lecture 9: Tall Building and Cities
How do market forces create urban-form order
Business land uses in CBD have a high bid rent gradient > Travel time means a lot to office workers
working in the CBD and thus the bid-rent gradient is v steep > this is because the face to face
interaction is important to business or financial services and thus they have to live near the workplace
for better interaction
Land Rent (Price), Building Height, and Capital-Land Substitution
Willingness to pay for office space depend on accessibility to other other office firms
● As firms use offices as production facilities to gather, process and distribute tacit
information > this information cannot be codified for distribution on paper or webpage.
○ Such information involves interactions between workers from different firms, and
firms can reduce travel time for interaction by locating close to related firms.
Hence, the transmission of tacit information requires face-to-face contact
between high-skilled workers who have a high opportunity cost of travel.
○ So the key determinant in the price of office space is accessibility. Firms willing to
pay more for more office space that is accessible to other office firms. But the
price of the office varies in 3 dimensions - Latitude, longitude and altitude
●
Latitude & Longitude (Surface location)
The willingness to pay for office space at a particular location depends in part on the site’s
accessibility to office firms at other locations.
●
●
●
●
The principle of median location can be applied here.
○ Total travel distance is minimised at the central location (Point C)
○ A move from the median location to the intermediate location increases travel
distance.
○ Ultimately, as we move farther away from the central location to intermediate and
endpoints progressively, we are closer to fewer firms progressively > As a result,
total travel distance increases progressively larger amounts
Willingness to pay for office space at different locations: WTP = TR - TC
●
●
○ Figure 12:
■ The total revenue does not vary with location and thus is a straight line.
■ The total cost is the sum of interaction travel costs + other costs
(constant). But we assume other costs do not vary across other spaces. As
the distance from the centre increases, the travel distance increases at an
increasing rate, and so the interaction cost increases at an increasing rate
as well. Thus, the total cost curve is convex.
○ The WTP is the difference between total revenue - total cost
■ It is negatively sloped and concave because;
● Negative Slope: Interaction travel cost increases with the distance
to the centre. The greater the distance location, the higher the
interaction travel cost and thus less profitable. As a result of this,
firms are willing to pay less for office space.
● Concave: As we move away from the centre, interaction travel
cost increase at an increasing rate, meaning that the willingness
to pay decreases at an increasing rate.
Labour market and willingness to pay for office space
○ Labour accessibility translates into a higher willingness to pay for office space
■ What is the relationship between labour accessibility and wage?
● Labour accessibility refers to the ease with which workers can
access employment opportunities
● The more accessible labour is, the lower the wages employers
are willing to pay. Because, if there are many workers available
for a particular job, employers can be more selective and offer
lower wages because workers are more likely to accept lower pay
due to competition for jobs
○ Wage paid to office workers compensates workers for commuting costs, so office
locations with low commuting costs can pay lower wages to the workers > Lower
wages mean lower production cost > higher WTP for office space
○ But how do we determine labour accessibility?
■ We have to look at where the firm’s workers reside.
> For widely dispersed residences, it means workers live throughout the
city, labour accessibility is the greatest in the city centre, i,e the median
location for the office firm, and thus wages are the lowest in this context.
> For concentrated residences, it means workers live in a specific area of
the city, and wages are lowest close to the workers’ residential area as the
labour accessibility is the greatest. But wages will increase as the firm
moves away from that particular area
Altitude (Building height)
Look at how price of office space varies within the building, i.e how price varies from floor
to floor & explore the profit maximising firm’s decision about building height
○ Hence, this provides a framework to determine the willingness to pay for the land
under office buildings
Price of Office Space & building height
a) Positive and Negative WTP
● Assume, an office firm has chosen a particular location.
○ Base price office space for ground level office space determines by the
accessibility of the site to other office firms and workforce
● But how much is the firm willing to pay for office space on higher floors - the second,
third, fourth? There are 2 factors to consider
1. Intra-building travel cost: As firm’s vertical travel cost increases, the firm’s
willingness to pay for office space decrease
2. Altitude amenity: There are better view and sense of higher status for higher level.
So in a competitive labour market, better working conditions generate lower
wages. Because there are many workers available for a particular job, employers
can be more selective and offer lower wages because workers are more likely to
accept lower pay due to competition for jobs. Thus, if wages decrease as altitude
increase, the willingness to pay (WTP) for office space increases with the floor
level.
○ Combined Effect of intra-building travel cost + altitude amenity
■ Stairways: Travel cost increases rapidly. Although, the amenity could
minimise the negative effect of travel cost on willingness to pay, the sharp
increase in travel cost is too high for amenity effect to offset > WTP is
negatively sloped
■ Elevator: Travel cost is very high at the first few floors because they can
either use stairs or incurred fixed time cost for an elevator. But as level
start to increase, the travel cost increases slowly because elevator moves
quickly from one floor to the next. Hence, the amenity effect could offset
the travel cost in this case > WTP is positively sloped
●
b) Profit maximising building height
● Use marginal principle to choose profit maxismising height
○ MB: Additional floor is the additional revenue that can be collected from office
○
●
●
firms on the floor. Eg: Each floor has one unit of office space > additional revenue
is the price of office space
MC: additional construction cost from building one more floor
■ MC is positively sloped because taller building requires more
reinforcement to support its more concentrated weight > greater number
of floors, construction costs increases at an increasing rate
MB = MC at h* > profit maximising height
Willngness to pay for land
○ Can use building height framework to show how much building firm is willing to
pay for the land under the building
○ WTP = economic profit
■ Economic profit is the gap between MB and MC (b & c) for h’
○ Competition among building firms ensure the price of land equals to WTP. As the
competitive bidding will bid up the price of land until it reaches the economic
profit from using the land. This is leftover principle > competition among
potential land users ensure the economic profit goes to landowners
Effects of greater accessibility in the base price of office space: Base price of office space
varies with the accessibility to other office firms.
○ Moving closer to the center suggests greater accessibility to other office firms
which generates a higher base price of office space.
■ First effect: Greater accessibility > higher base price of office space >
generates higher marginal benefit for building height and thus increases
the profit maximising building height
■
■
Second effect: Base price of land is higher for being close to the city
center > economic profit of the more accessible building is higher. This is
shown by a larger shaded area between the MB & MC (higher MB & MC).
Thus, greater accessibility translates into higher price of land (price of
land= WTP = economic profit)
Overall, there is positive correlation between taller buildings (FAR) and
higher land prices
●
How would a lower interest rate affect optimal FAR
○ Lower interest rate > Lower production cost > Decrease MC > Higher FAR & WTP
●
Increased MR > Increased FAR (building height) > Increase WTP & Higher Bid Rent for land
○ Builidng height increases with MR, which increases tgt with either price (p) or
floor price (pq)
○
○
Floor price (Leasing Price; rental) increases with building height
Capital-Land Substitution
●
●
●
●
●
Q = F(K, L)
Profit to the builder = (floor area price * lot size) - (interest rate * capital) - (Land Rent *
Lot Size)
○ pQ - rK - RL
Profit maximising combination requires: MRS = Land Rent / interest rate
○ R/r
The perspective in the capital-land substitution is to minimise the cost of producing the
building with a fixed amount of office space. It involves choice of 2 inputs to the
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●
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production process > capital and land
○ Point s: short building (capital is small) on a large quantity of land (lot size is large)
○ Point m: medium height building
○ Point t: tall building (high capital) on a small quantity of land
■ Taller building requires more capital because it requires extra
reinforcement to support its more concentrated weight (more capital) and
transport systems for (more capital) vertical travel within the building
MRS: Marginal rate of substitution between capital and land > Marginal product of land
over marginal product of capital > Indicates saving in capital cost from an additional land
area input, holding the floor area output unchanged
○ MRS = Land Rent / interest rate
Point s: Low land price at remote location (shown by larger lot size). Thus the isocost is
relatively flat at remote location MRS = Low
○ Short building is profitable where R/r or land price is low > entails a small MRS
Point t: High land price at highly accessible location. The isocost is steep, so MRTS = high
(a tall building). When price of land is high, the benefit of building up (less land used)
exceed the cost of building up (more reinforcement and vertical transportation)
○ Tall building is profitable where R/r, or land price is high > entails a high MRS
Point m: medium land price. The isocost has midrange slope, so MRTS = input price ratio
at a medium capital:land ratio (medium height building)
Overall, this graph suggest that a high price of land generates tall buildings as firms substitute
capital for relatively expensive land (more capital so as to build higher)
Skyscraper Boom and Curse
Capital and land substitution tells us that firms build tall building due to high price of land. But
studies show skyscrapers result from competition between firms for the tallest building in the city.
As the competition to be the tallest building increases the building height beyond the profit
maximasing height.
But why?
●
●
As firms view the value of advertising from being labeled the tallest building > Corporate
branding value of owning the tallest building in town
Becomes the landmark building in the world
In 1999 Andrew Lawrence, then of Dresdner Kleinwort Benson, an investment bank, identified
what came to be known as the “skyscraper curse”. Mr Lawrence noticed a curious correlation
between the construction of the world’s tallest buildings and economic crises. The unveiling ofthe
Singer Building and the Metropolitan Life Tower in New York, in 1908 and 1909 respectively,
roughly coincided with the financial panic of 1907 and subsequent recession. The Empire State
Building opened its doors in 1931, as the Great Depression was getting going (it was soon dubbed
the “Empty State Building”). Malaysia’s Petronas Towers became the world’s tallest building in
1996, just before the Asian financial crisis. Dubai’s Burj Khalifa, currently the world’s tallest
building, opened in 2010 in the middle of a local and global crash - The Economist, Mar 26th, 2015
Problems with building more skyscraper
● The competition between nations in building the tallest’s building will eventually create an
oversupply of office space
○ Office vacancy rates rise and rents fall, making new skyscrapers financially
unsustainable
● Credit supply issue: Amount of credit supply that is available depend on the perceived risk
of the project, financial strength of developers, and the state of overall economy
How globalisation contributes to the Skyscraper boom in the past 20 years
1. Increased demand for urbanisation
a. More people migrate to cities in search of economic opportunities > higher
demand for real estate > led to more skyscraper to accommodate the growing
population in urban areas
2. Growth of international businesses and agglomeration of economies
a. The rapid growth of international businesses has created need for global business
hubs > countries like NY, Londan, Hong Kong, Singapore have become the global
financial trade hub > thus, the demand for office spacehas drive the construction
of skyscraper
3. Technological advancements
a. Globalisation has facilitated the exchange of knowledge and technology across
borders, leading to new and innovative construction techniques > enabled the
construction of taller and more complex buildings
4. Competition
a. Globalisation has created a competitive environment in which cities and countries
compete to attract businesses, investors, and tourists. The construction of iconic
skyscrapers is a prominent way to showcase a city’s economic and technological
progress and to attract international attention
Lecture 10: Urban Transportation
Density Gradient (Urban Form) and urban transportation technology
Density in the city centre increased first and declines
Why are older cities denser?
Older cities are often denser because old cities establish earlier, so they are designed for bicycles,
pedestrians and other older modes of transportation. Hence, they are designed within walkable
distance and thus is more compact and thus compact
Rise of automobile travel and the road congestion problem
Rising of automobile
● Influx of vehicles led to conflicts over the room in public space for moving and parked cars,
pedestrians and bicyclists.
●
Apart from the increase in the number of cars that pose challenge to public life, urban
density decreased also because fewer people per housing unit, and people had more
individual space. That too was a challenge to creating lively cities.
Traffic Congestion
● Traffic Congestion refers to the incremental cost resulting from interference among road
users
○ These become significant when traffic volumes approach the road’s capacity. This
leads to negative externalities such as a reduction in traffic mobility, increased
driver stress, vehicle costs and pollution.
■ As additional vehicles on the road decrease the space between vehicles,
drivers naturally slow down to maintain safe distances between
vehicles.
○ Hence, when the roadway approaches its maximum capacity, even a small traffic
reduction can significantly increase flow rates.
Private Trip Cost vs Social Trip Cost
External Cost
● With reference to the graph, there are v other road users, the opportunity cost of travel
time is c, and the marginal external cost (MEC) of additional vehicle = m * v * c. In this
case, m = 0.01, v = 1200, c = $0.20.
● m = 0.01 indicates an additional vehicle increases the travel time of each other user by
0.01 minutes and the opp cost of travel time (c) is $0.20 per minute.
○ So marginal external cost = $2.40 > Additional vehicle imposes a cost of $2.40 on
other highway users ($6.40 - $4.00)
● But marginal external cost depends on traffic volume.
○ For low traffic volume
1. The value of m (additional time per vehicle) will be relatively low, and will be 0
when the volume is low enough that all vehicles can travel at the legal speed limit.
2. The value of v (number of affected users) will be relatively low.
Private Cost
● Refers to the cost of travel experienced by an individual driver. In the graph, it is the
lower of the two curves.
● Private Cost = Monetary Cost + Trip Time Cost (Time cost of travel along a stretch of
highway)
○ Monetary Cost is constant per trip, but trip time cost depends on the traffic
volume (it is lower for uncongested traffic).
○ Hence, for higher volumes, the spacing between vehicles decreases, causing
drivers to slow down to maintain safe distances between vehicles. A slower speed
more travel time and thus higher trip time cost. Thus, this will lead to an increase
in trip time cost, and with a constant monetary cost which gives overall higher
private cost due to traffic congestion.
Social Cost
● Social Cost = Private Cost + External Cost
○ The gap between the two curves is the marginal external cost of travel.
● At V’, the private cost is $4, the social cost is $6.40, and thus the external cost is $2.40
○ As the volume of travel increases, the external cost increases, widening the gap
between 2 curves. At v’’, the private cost is $4.80, the social cost is $9 and thus
external cost is $4.20.
Market Equilibrium vs Efficient Outcome
●
The demand Curve depicts the marginal benefit of traffic volume.
○ It is negatively sloped: an increase in the cost of using the road decreases the
number of people for whom the cost exceeds the willingness to pay. So fewer
people will use the road.
Market Equilibrium is shown by point c, where the market demand curve intersects the private
cost curve at v*. For total v* users, the benefit of using the highway is greater or equal to the
private cost of the trip > It shows the willingness to oay for the trip by the last user.
Efficient equilibrium is at which marginal social benefit equals to marginal social cost. Hence,
efficient outcome maximises the social welfare of road use. No positive externalities associated
with travel, so the demand curve shows the marginal social benefit of travel. While the MSC
includes both private and social cost of travel.
MSB = MSC > The interaction of the 2 curves is at v^e.
But any trip beyond v^e contributes to social welfare loss
Hence, the market equilibrium outcome is inefficient, traffic volume and congestion level is too
high. So we need to charge users a road-use fee for them to internalise the congestion externality
by imposing congestion tax.
Efficient Road Use and Congestion Tax
Congestion Tax raises private trip cost and thus reduce the market equilibrium traffic volume. To
shift the v* (market equilibrium) to v^e (equilibrium optimal), congestion tax should equal
external cost: $6.40 - $4 = $2.40. The demand curve intersects social trip cost at $6.40 and the
private cost is $4 at v^e. Hence, the difference between the social trip and the private cost is the
external cost which is $2.40.
Tax = External Cost = $2.40
How do we achieve efficient by tax?
1. Decrease volume: For eg, at point L, the willingness for that individual is $5.50, which is
less than the $6.40 cost (private cost + $2.40 tax). Thus, she will not use the highway.
2. Efficiency Gain: Thus, the gain from keeping L off the road equals the social cost avoided
minus her benefit foregone.
● Gain from keeping L off = Social Cost avoided - benefit foregone
○ Gain = $7.70 - $5.50 = $2.20
○ The social cost for user L is $7.70 (point f), and her benefit is $5.50
(willingness to pay). Hence, the gain from keeping L off the road is $2.20.
For the whole market, the efficiency gain from keeping vehicles off the
road from v* to v^e is shown by the shaded area.
Welfare Gains of road congestion tax - Can an optimal congestion tax benefit all road users?
Assume v* = 600, v^e = 500. 100 users are diverted by the tax. Hence, the tax revenue = $2.4 x
500 = $1200.
●
To benefit all road users, the revenue can be equally shared by the original road users v*
via tax refund of $1,200/600 = $2
○ Before the tax, the private cost is $4.80 (point c).
○ After the tax, the private cost is $6.40 (point e).
■ Increase in cost: $1.60
○ After the tax refund, the private trip cost is $4.40 ($6.40 - $2)
○ Hence, v^e road users save $0.40 ($2-$1.60)
●
On the other hand, the maximum loss in consumer surplus due to congestion tax is $6.40
- $4.80 = $1.60. But after the tax refund, the diverted users, due to high private costs,
receive a net gain of at least $0.40
Overall, optimal congestion tax can benefit all road users provided the tax revenue is fully
refunded to all road users (including the diverted users) via an equal lump sum payment
that makes users better off.
○ Road users: Choose to use the road and pay the tax can save $0.40 per trip
○ Diverted users: Choose not to use the road and receive compensation net of
their lost surplus at least $0.40
○ Hence, optimal congestion tax eliminates the welfare loss due to excess
congestion, after-tax total consumer surplus plus the tax revenue exceeds the
total consumer surplus before the congestion tax is implemented.
●
Illustration of loss of consumer surplus due to congestion tax
For consumers at L on demand curve, the $5.50 exceeds the $4.80 (pre-tax price) but is less than
$6.40 (post-tax price). Hence, consumers experience a loss of CS of $5.50 - $4.80 = $0.70. But the
net gain for L is $1.30 due to tax refund ($2 - $0.70). Thus, tax refund is large enough to cover any
loss of consumer surplus.
If the tax refund were lower, some consumers might experience net losses.
Dynamic road-use pricing: peak vs off-peak congestion tax
Efficient congestion tax on a roadway varies with the volume of traffic.
For figure 18-7, When travel demand is relatively high, there is a relatively large gap between
private and social costs, and, thus a relatively large congestion tax. In the case of low demand,
the market demand curve intersects the private cost curve along its horizontal segment. In this
case, traffic flows at the speed limit, and there is no congestion externality, and thus no
congestion tax.
Figure 18–8 shows estimates of the efficient congestion taxes per mile for three metropolitan
areas. For the two U.S. cities, the peak-demand tax is roughly ten times the off-peak tax. For
London, the peak-demand tax is five to six times the peak tax for the U.S. cities, and the differences
in the off-peak taxes are even larger. On average, the efficient peak-demand congestion tax for
U.S. cities is $0.085 per mile.
Singapore was the first city to use road pricing to manage road congestion
1975 - ‘Area License System’: First in the
world
1998 - ‘ERP’
A cordon pricing system under which
drivers were charged about $2 per day to
travel in a special toll zone in the central
area of the city.
A smart-card system with user charges
that increase with the level of congestion.
Initially, carpools, taxis, motorcycles,
buses, and commercial vehicles were
exempted.
The system has 28 gantries that charge
users for entering the central area during
the daytime. In addition, 14 of the city’s
highways are subject to tolls during the
morning peak period on weekdays.
Benefits: cut down traffic, improved air
quality, and raised financial resources for new
roads and public transit.
ERP rates are to achieve an optimal speed
range of 45 to 65 km/h for expressways
and 20 to 30 km/h for arterial roads
Impact of congestion tax on utility
Context: Two cities consist of 12 million workers in total.
● Congestion tax shifts the city’s utility curve upward > internalisation of congestion
externalities decreases the magnitude of the diseconomies of agglomeration
○ So it reduces the downward drag on utility as city size increases. The vertical
shift is relatively small for a small workforce, where congestion is light, and
relatively large for a large workforce, where congestion is heavy.
● In the congestion-tax city, the utility level increases from u* (point a) to u″ (point b).
○ In the absence of migration, utility in the congestion-tax city would exceed the
utility in the other city by u″ − u*. This is not a Nash equilibrium because there is
an incentive for unilateral deviation.
○ In response to the utility gap, workers will migrate to the congestion-tax city, and
○
○
migration will continue until the utility is equalised across the two cities.
The new regional equilibrium is shown by points c and d.
■ This is a Nash equilibrium because both cities have the same utility level
u**, and the workforces in the two cities add up to the fixed regional
workforce.
■ The congestion-tax city (shown by point d) gains 1 million workers, while
the other city (shown by point c) loses 1 million workers.
Utility increases from u* to u** in both cities, meaning that workers in both cities
benefit from an efficiency-enhancing congestion tax in one city.
■ Workers in the other city benefit because the decrease in its workforce
causes the city to move upward along its negatively sloped utility curve
from point a to point c, where u** > u*. The benefits of a congestion tax
in one city spread to other cities in the region.
The benefit of road capacity expansion and congestion tax
Going Car-Lite
Other externalities of road use by cars
1. Traffic accident
2. Environmental impact
a. Emission, heat, noise, excessive road construction damaging ecosystem
Apart from using tax tool to minimise these externalities, we also need to provide viable healthy
alternatives to driving. We need to create infrastructure for public transportation and active
mobility - going car-lite
Singapore context
Four public housing estates - Ulu Pandan, Mount Pleasant, Tengah and the Greater Southern
Waterfront - will be gazetted as car-lite in a push towards sustainability.
Car-lite areas are planned upfront with public transport, walking and cycling connections, allowing
for the provision of fewer parking spaces
Advantages and Disadvantages of Public Transport
Advantage
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When it is operating near capacity,
any form of public transport is more
energy efficient, more
environmentally friendly, and makes
better use of scarce road space than
private automobiles
○ A single bus can carry as many
people as 60 cars. A single
train does the work of 1,000
cars
Saves trip cost when passenger
volume is high
○ Bus system has a lower
average trip cost than auto
when corridor volume
exceeds 1,100 passengers per
hour
○ Rail has a lower average trip
cost than auto when corridor
volume exceeds 22,000
passengers per hour
Create no congestion problem
○ Passenger travel choices
would always be socially
Disadvantage
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High capital cost
Not efficient in serving areas with low
population density
Do not go everywhere
Rail lines can quickly become
obsolescent as travel pattern change
An integrated bus system is nearly
always more cost efficient than the
fixed-rail system in urban areas
U.S. experience
○ A dozen cities have built
rail-transit system since the
late 1970s. Total ridership in
1995 was no higher than in
1977.
efficient