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URBAN SIZE. As city grows, the benefits of agglomeration economies are partly offset by several costs: longer commuting times, higher land costs, more congestion and pollution How does an increase in city size affect the welfare utility (welfare) of the typical worker?.

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Urban size

  • As city grows, the benefits of agglomeration economies are partly offset by several costs:

    longer commuting times, higher land costs, more congestion and pollution

  • How does an increase in city size affect the welfare utility (welfare) of the typical worker?

Wage curve: wage as a function of the

local labour force, w(N), is increasing in

the size of the labour force reflecting

agglomeration economies

Combes et al. (2005)

Cost of living curve: commuting, housing

and other consumption goods

Labour supply curve: indicates for any

level of net wage, the amount of labour

supplied in the area (here it is assumed

perfect mobility)


  • Cities of different size and productive specialization can be found in all the economies

  • Specialized and diversified cities co-exist

  • Medium size cities tend to be highly specialized in their production patterns, in terms of goods exported form the city

  • All cities have a base of locally produced goods and services just for local consumption: housing, retail and personal services, business services, repairs and education and health services. (about 60% of total employment)


Most metro areas have no employment

None of metro areas > 1m even have 1% of employment in textile

Most of specialized areas are medium-small


Most metro areas have no employment

Very large metro areas record small shares

Some areas >1m. record shares that are almost 4% of local employment

Why is there specialization?

  • The effects of economies of localization specific to industries

    (different industries have different effects of economies of localization)


  • Agglomeration costs depend on urban size (they are not specific to industry)

    E.g.: Brasil 70s 10.000 hab. → 1m. Cost of living rose 2.5-3 fold

    For the US between small and vary large, cost of living differentials, 80%-100%

    For firms this means wage and land costs rise with city size

  • If economies of agglomeration are internal to the industry

    • A firm only benefits from locating near others of its own type

  • City specialized in food production + City specialized in chemicals

    → Everyone loses

  • Production activities unrelated → No productivity gains

  • Combining those cities escalates commuting distances, congestion, rents, pollution,...

  • Cities stay separate

  • What about large metro areas? sizes

  • Large areas tend to be more service

  • Larger areas have higher than national average share of employment in FIRE

  • → Export to other cities

Large areas tend to have very diverse manufacturing bases sizes

Herfindahl index for manufacturing industries decreases with urban size

Why is it that we find any manufacturing in large metro areas and

why is the base so diverse?

Low productivity in both industries, textiles and instruments, in large cities

  • There are at least two general types of manufacturing activity in large metro

  • areas

  • Both require large local diverse labour and product markets to thrive

    • Arts, publishing and high fashion apparel

      • Volatile markets (trends are set and broken and products are tested locally

      • Require a diverse local market (hire just the right people with special talents for just the right job)

      • Agglomeration effects due to urban size, not just industry size (Economies of urbanization)

    • R&D activities

      • New products undergoing development need to be “tested” in large local product markets

      • Require a very diverse and alive environment, where ideas flow freely across firms

      • Require very specific skilled employees for very specific developments (large diverse labour market)

      • R&D activities don’t show up in “output” in productivity figures above

  • Larger cities have become specialised in management functions whereas smaller cities have become specialised in production

  • This urban transformation is interrelated to the increasing separation of the management and production facilities of individual firms

  • Recent studies find patterns in the location of headquarters and business services:

    • Headquarters have a strong propensity to out-source business services

    • Headquarter location decisions are mostly driven by the existence of a large and diverse local supply of business services rather than by the presence of other headquarters

  • Model functions whereas smaller cities have become specialised in production

  • Firms, in each sector, require both sector-specific inputs as well as business services for their headquarters

  • There are agglomeration economies in all sectors

  • Firms face a trade-off between spatial integration of both headquarters and production facilities and the spatial separation of these two functions

  • If firms decide to split, then both parts of the operation can fully benefit from the relevant agglomeration economies:

    • Sector specific inputs for production

    • Business services for headquarters

  • Spatial integration

    • Firms manage the interaction between production facilities and headquarters more efficiently because of savings on communication costs

    • But more expensive inputs due to crowding

When communication costs high functions whereas smaller cities have become specialised in production→ split costly → low demand for labour from spatially disintegrated firms → firm will pay low wages

When communication costs low → separation efficient → cities specialized by function → each function benefit from specific agglomeration effects → headquarters will pay higher wages