Introduction and Axioms of Urban Economics
Urban Economics

Urban economics combines both
economics and geography:
 Economics explores how people make
decisions under scarcity, while
 Geography explains where human activity
occurs.

Urban economics explores the location
choices of maximizing agents.
Areas of Urban Economics
Market forces within the development of
cities
 Land use
 Urban transportation
 Crime and Public Policy
 Housing and public policy
 Local government expenditure and
taxes

Urban Area
Urban area is defined based on population
density, the number of people living in a
given area.
 An urban area has a high population
density relative to surrounding areas. (Can
agriculture be the prominent activity in
cities?)
 Therefore, in an urban area there is
frequent contact between different
economic activities.

For a city to develop
Three conditions have to be satisfied for a
city to develop
 The first condition:
 Agricultural surplus
○ The rural dwellers must produce enough food
to provide for themselves as well as city
dwellers.
For a city to develop

The second condition:
 Urban production
○ City dwellers must produce something to
exchange with rural people for the food they
grow.
For a city to develop

The third condition:
 Transportation for exchange
○ An efficient network of transportation has to
exist to facilitate the exchange of food and
urban products.
The rise of an urban society

We will see later that the transformation
from a rural to an urban society was
facilitated by technological advances
that:
 increased agricultural surplus,
 Increased the productivity of urban workers,
and
 Increased the efficiency of exchange and
transportation.
Five Axioms of Urban Economics
1. Prices adjust to achieve locational
equilibrium
Locational Equilibrium is achieved when
given the prices of different locations
every one is satisfied with his location,
i.e. no incentive to move.
 Prices adjust so people are indifferent
between desirable and undesirable
locations.

2. Self Reinforcing Effects Generate
Extreme Outcomes

A change in something leading to
additional changes in the same
direction.

Example: Concentration of automobile
sellers in a certain area makes the area
more attractive for other automobile
sellers to locate, resulting in more
concentration.
3. Externalities Cause Inefficiency

When benefits or costs of a transaction
fall on a third party, the market outcome
is socially inefficient.
Pollution and Market Inefficiency
Price of
Aluminum
Marginal Social cost
(MPC+ external cost)
Tax=
External
Cost
Supply
(MPC)
Optimum
Equilibrium
Demand
(MPB)
0
QWELFARE QMARKET
Quantity of
Aluminum
4. Production is Subject to Economies
of Scale

Economies of scale occur when
doubling all inputs of production results
in more than doubling output.
worker
Number of machines
5
10
15
20
25
30
35
40
0
0
0
0
0
0
0
0
0
1
30
100
250
340
410
400
400
390
2
60
250
360
450
520
530
520
500
3
100
360
480
570
610
620
620
610
4
130
440
580
640
690
700
700
690
5
130
500
650
710
760
770
780
770
6
110
540
700
760
800
820
830
840
7
100
550
720
790
820
850
870
890
8
80
540
680
800
830
860
880
900
Economies of scale occur for two
reasons:

Indivisible inputs: when capital inputs
are lumpy and cannot be scaled down
for small operations.
Economies of scale occur for two
reasons:

Factor specialization: dividing production
into smaller tasks each undertaken by
few workers. This is possible with a
large scale of production.
Scale Economies and cost

When there are economies of scale in
production, the average cost of
production decreases as output
increases.
AC
AC
Q
AC
Q
Q
5. Competition Generates Zero
Economic Profit
In the absence of barriers to entry, we
expect firms to enter a market until
economic profit is zero.
 This implies that the factors of
production are earning their opportunity
costs, i.e., just enough to keep them in
business. In that case they are earning
normal profit

Example
Adam decided to open a bakery. He
could earn $50,000/ year in another job.
He withdraws his savings from the bank,
$100 000 , which was earning 7%. The
market for baked goods is a perfect
competitive market
 After paying all his expenses how much
money do you expect Adam to be
making in a year?
