\

Urban Economics
FIFTH EDITION

Arthur O'Sullivan
Deparlmenl of Economics
Lewis & Clark College

LIBROS
COMPAIA
Cnllc 19 No. 3-16 Local 104
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Telcfox: 34 1 71 00 Bogo1. O.C.

B McGraw-Hill
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Boston Burr Ridge, IL Dubuque. IA Madison. WI New York San Francisco St. Louis
Bangkok Bogot Caracas Kuala Lumpur Lisbon London Madrid Mexico City
Milan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto

CHAPTER 2

Why Do Cities Exist?

Man is the only animal that makes bargains; one dog does
not change bones with another dog.
- AOAM SMITH

c ities exisl because it is efficient to produce sorne goods on a large scale. An

activity is subject to economies of scale if the average cost of production decreases
when we scale up the operation and produce more output. The way to exploit
economies of scale is to concentrate production ata small number of sites. Because
workers can economize on travel time, cities develop around these production sites.
One of the folk theories of urban economics is that if there were no econornies of
scale, there would be no cities. In this case, every household would be self-sufficient,
producing its own goods and services in its own home. There would be no reason
for cities because the cost of urban living (e.g., a high price of land) would not be
offset by any benefits. As we'll see in this chapter, cities exist because the benefits
associated with concentrated production more than offset the costs of living in a high
population density.

A REGION WITHOUT CITIES

Under what conditions would a region have no cities? In other words, what set
of assumptions guarantees a uniform distrbulion of population? In this section,
we develop an economic model that generales a region without cities. This model
provides a list of assumptions that together preclude the development of cities. Later
in the chapter, we will relax these assumptions, and the new model will then predict
that cities will develop.
Consider a region that produces and consumes two goods: shirts and bread.
People use land to grow raw materials (wool from sheep and wheat) and take time
to transform the raw materials into shirts and bread. Travel within the region is by
foot: Residents walk ata speed of eight miles per hour (four round-trip miles per
hour). The following assumptions together preclude urban development.

19

20

Par! 1

Market Forces in the Developmen1 of Cilies

1. Equal productivity. Ali residents are equally productive at producing bread

and shirts. Similarly, ali land is equally productive in the production of raw
materials.
2. No scale economies in production. Production is subject to constant retums
to scale; a worker produces one s hirt per hour, regardless of how many shirts he
or she makes. Similarly, the amount of bread produced per hour is independent
of the volume produced.
3. No scale economies in transportation. The transpo1t cost per unit shipped per
rnile is independent of the volume shipped.
These assumptions eliminate the possibility of trade. Every household in the
region will produce its own bread and shirts. Because every household is equally
productive in producing both goods, there are no advantages from specialization and
trade. Although you could specialize in bread and exchange your surplus bread for
shirts produced by someone else, you are justas efficient as everyone else in producing shirts, so there is no advantage from specializing and trading. The disadvantage
of trade is that it takes time away from production. Moreover, there are no economies
of scale, so each person will produce one shirt or one loaf per hour, regardless of
how much he or she produces. Therefore, it would not be sensible to bui ld a shirt
factory ora bakery to produce on a large scale. Again, the disadvantage of centralized production is that trade takes time away from production. To summarize, there
are no advantages from trade or centralized production, so every household in the
region will be self-sufficient.
In this case, the population will be distributed uniformly throughout the region.
To see the reason for the uniform concentration, consider what would happen if
there were a concentration of population at sorne location in the region. The higher
deni.and for land at that location would bid up the price of land, and households 1iving
in the concentration would be worse off than those living elsewhere. In response,
the households in the concentration would move to places with lower land prices. In
this equilibrium, there would be a uniform price for land and a uniform population
density. There would be costs from concentrated production (higher land prices),
but no benefits, so there would be no cities.

TRADING CITIES
Our model of the region without cities assumes that all households are equally
productive in the production of shirts and bread. In this part of the chapter, we'll relax
this assumption and show that comparative advantage may lead to the development
of trading cities. Historically, trading cities developed to facilitate trade between
people in different pa1ts of a region.

Comparative Advantage Generates Trade

In our model of the region without cities, we assume that all households are equally
productive in the production of shirts and bread. If this assumption is relaxed, one

l.'i\JIVL

Chapter2 WhyDoCitiesExist?

. _ ..

'

21

Ut

-' NI. ., . .
,,
" ,part of the region may have a comparative advantage irrsfrt production, and the
other part may have a comparative advantage in bread production. It is possible-but
not certain- that comparative advantage will cause specialization and trade.
The notion of comparative advantage can be explained with a simple nume rical
example. Suppose that the northern half of the region is more productive than the
southem half. In Table 2-1, the North has an absolute advantage in producing both
bread and shirts; northem residents produce twice as much bread per hour and six
times as many shirts per hour. The differences in productivity could be caused by
differences in labor skills, weather, or natural resources.
The notion of comparative advantage is based on the principie of opportunity
cost. In a one-hour period, a northern worker can produce either six shirts or two
loaves of bread. Therefore, the opportunity cost of a shirt is one-third loaf, and the
opportunity cost of bread is three shirts. A southern worker can produce either one
loaf or one shirt, so the opportunity cost of bread is one shirt, and vice versa. The
North has a comparative advantage in the production of shirts beca use the opportunity
cost of shirts is one-third loaf of bread, compared to one loaf in the South. Similarly,
the South has a comparative advantage in bread because its opportunity cost of one
loaf of bread is one shirt, compared to three shirts in the north.
Comparative advantage may lead to trade between the North and South. To
explain the possible advantages of trade, suppose that al! households in the region
are initially self-sufficient. Suppose the exchange rate is two shirts per loaf of bread;
that is, the price of bread is two shirts. If both regions move in the direction of
specialization, both can get more goods to consume. As shown in the first row of
Table 2-2, ifa northern household switches one hour of work from bread production
to shirt production, it produces six additional shirts but two fewer loaves of bread. If a
southern household switches three hours from shirt production to bread, it produces
three more loaves but three fewer shirts. As shown in the second row of numbers,
given the exchange rate of two shirts per loaf, the northern household can exchange
TABLE 2-1 Comparative Advantage
Output per Hour
South

Opportunit)' Cost

North

South

North

1 shirt
1 loar

3 shirts
1/3 loaf

Bread
Shirts

TABLE 2-2 SpeciaJization and the Gains from Trade

North

Change in production
Exchange 2 shirts per loaf
Net effect of change in production
and exchange

South

Bread

Shirts

Bread

Shirts

-2 loaves
+3 loaves
+ l loaf

+6 shirts
-6 shirts

+3
- 3 loaves

-3 shins
+6 shirts
+3 shirls

22

Part 1 Market Forces in the Developmcnt of Citics

its six extra shirts for three loaves of bread from the southern household. On the
ftip side, the southern household exchanges its three extra loaves for six shirts.
As shown in the last row, the northem household has a gain of one loaf of bread,
while the southem household has a gain of three shirts. In this case, each household
benefits from a move toward specialization in the good for which it has a comparative
advantage.
What about transportation costs? Trade between the two households will be
beneficia! if the transportation costs involved in trading aren't too large. Suppose
that it takes an hour to execute a trade. For the northem household, the opportunity
cost ofthe hour spent trading is the amount ofbread the household could produce for
itself during this time. The opportunity cost is two loaves so it would not be sensible
to trade. If, however, the travel time is less than a half hour, the household would
have a net gain from trade. For example, it the trade takes only one-fifth of an hour,
the opportunity cost is four-tenths of a loaf, leaving a net gain of six-tenths of a loaf.
Similarly, the southern household would have a net gain. Therefore, households in
the two regions will speciali ze and trade, exploiting their comparative advantages to
increase consumption.
Although there is now specialization and trade, there wi ll not be any cities.
Given the fourth assumption (no scale economies in transportation), households in
the two regions will engage in direct trade. Each northern household will link up
with a southem household to exchange shirts and bread. There is no reason for an
intermediary because individuals can transport goods as efficiently as someone who
transports goods in bulk.

Scale Econornies in Transportation and Trading Cities

We can extend the model to incorporate scale economies in transportation. Suppose
the transport cost per unit per mile decreases as the vol u me transported increases. In
this case, it will be cheaper to transport shirts and bread in bulk, and it will be sensible
for individual households to rely on intermediaries (middlemen or rniddlefolks) to
collect, transport, and distribute shirts and bread. From the perspective of individual
households, it will be sensible to pay middlefolks sorne amoum of bread to transport
the goods, freeing up time to produce more outpul. For the northem household,
paying the middlefolks one-tenth of a loaf would be better than spending one-fifth
of an hour (at a cost of 0.4 loaves) transporting the bread and shirts. Similarly, the
southern household would be better off paying something less than one-fifth of a
shirt to have someone else take care of transportation.
To fully exploit scale economies in transportation, a trading firm must collect and
distribute a large volume of output. A trading firm will locate ata place convenient
for the collection and distribution of goods, causing the development of marketplaces
at crossroads, ports, river junctions, and other transshipment points.
The location decisions of traders cause the development of market cities. People
employed by the trading firms will live near the marketplace to economize on commuting costs, and will bid up the price of land near the marketplace. As the price of
land increases, residents will economize by occupying relatively small lots. In other

Chapter 2

23

Why Do Cities Exist?

words, the population density around the marketplace will be higher than in the rest
of the region. A city is defined as a place with a relatively high population density,
so the combination of comparative advantage and scale economies in transportation
causes the development of a market city.
The market city develops because three conditions are satisfied. First, productivity is high enough that people outside the city produce enough bread and shirts
for themselves and the urban traders. The agricultura! surplus feeds and clothes the
urban workers. Second, the differences in productivity that generate comparative advantage are large enough to offset transportation costs, so trade occurs. Third, there
are scale economies in transportation, meaning that intermed iaries (middlefolks) are
more efficient at transporting and marketing goods, generating central marketplaces.

Historical Insights: The English Woolen lndustry

Before the Norman Conquest in 1066, the making of wool cloth in England was an
entirely local affair. Individual households and villas raised their own sheep, spun
the raw wool into yarn, and wove the yarn into cloth. In other words, households
were self-sufficient in cloth production, and no cities were involved in the production
or trade of wool cloth. A small number of towns and cities were involved in local
trade.
The Norman Conquest increased the interaction between England and the continent, setting the stage for the development of the woolen cloth trade. The barriers
to trade fell, and England was able to exploit its comparative advantage in the production of wool cloth. Exports to the continent rose, causing the development of
small cities and towns based on the cloth trade.

FACTORY CITIES
T he third assurnption underlying the region without cities is the constant returns to
scale in production. Specifically, each worker can produce either one shirt or one
loaf of bread per hour, regardless of how much the worker produces. There are no
advantages from centralized production in factories, so ali goods will be produced
in homes. Jf we drop the assurnption of constant returns to scale and introduce
scale economies in the production of shirts, factory production may replace home
production, causing the development of factory cities.

Scale Economies and the Shirt Factory

Suppose that there are advantages from the large-scale production of shirts. In other
words, as the volume of production increases, the labor required to produce one
shirt decreases. Figure 2-1 shows the average labor times for different arnounts of
factory shirts. The average labor time decreases frorn one hour for one shirt (the
sarne time as home production) to one-fourth hour for an output of 400 shirts. T hese
scale econornies arise for two reasons.

24

Part 1

Market Forces in the Development of Cities

FIGURE 2-1 Scale Economies in Shirtmaking

0.50

:e
"'

8::>

:,

"'E
...o
..J
'"

0.25

J:>

200

400

600

Number of shirts
If there are scale economies in shirtmaking. the average time required 10 make a shirt dccreases as thc
volume produced increases.

l. Factor specialization. A home worker performs ali the tasks associated with
making a shirt: The raw wool is spun into yarn; the yarn is woven into cloth; the
raw cloth is finished; the pieces of the finished cloth are sewn in to a shirt. A large
operation allows labor specialization with each worker being assigned a single
task; there could be spinner, a weaver, a finisher, anda sewer. The specialization
of labor increases productivity because (a) a worker's productivity increases
with repetition and (b) a worker spends less ti me switching from one production
task to another.
2. Indivisible inputs. An input to the production process is indivisible if the input
has a mnimum efficient scale. If an indivisible input is cut in half, the total
output of the two halves is less than the output of the whole. T he shirt factory
uses equipment (spinning machines, power looms, and sewing machines) that
cannot be efficiently scaled down for use by individual shirtmakers. As output
increases, the factory uses more indivisible inputs, increasing productivity.

If the shirt factory produces 400 shirts per day, it wi ll employ 100 workers, each of
whom produces four shirts per hour.
What about the wage of factory workers and the price of a shirt? The wagc must
be high enough to make shirt workers indifferent between working in the factory
and working at home. Recall that a home worker can produce one loaf of bread per
hour. To make the shirt worker indifferent, the wage must be one loaf of bread per
hour of factory work. To keep the example simple, suppose that there are no other
costs of producing shirts. Because each worker produces four shirts per hour, and is
paid one Ioaf, the firm 's production cost per shirt is 0.25 loafof bread.

Chap1er 2

25

Why Do Cities Exist?

Under what circumstances will a household buy factory shirts instead of producing them at home? The net price of a factory shirt is the price paid to the firm
(0.25 loaf) plus the consumer's opportunity cost of the time spent traveling to and
from che factory. The opportunity cost is the loss of bread production resulting from
traveling instead of producing bread. A household can produce one loaf pcr hour,
so it will be sensible to buy a factory shirt if the trip takes less than 0.75 hour. For
example, if the trip takes only 0.20 hour, the net price of a factory shirt is 0.45 loaf =
0.25 loaf paid to the factory plus 0.20 loaf sacrificed in travel time. The household
will be indifferent if travel time is 0.75 hour; in this case, the net price is 1 loaf =
0.25 loaf paid to the factory +O. 75 loaf for travel.
Figure 2-2 shows the market area of the shirt factory. The market area is defined
as the area over which the factory underprices home production. The vertical axis
FIGURE 2-2 Market Arca of Shirt Factory
Cost of factory >hin

Cost of fac1ory shirt

1.00 t - - - - _ . . . . . , , . . - - - - - - - - - - - - - - - - , f - - - - Cost of
,,

0.75

......

B050

1
1
1

V
;:;

1
1

homemadc >hirt

1
1

0.25

Travcl cost

______ .._
1
1
L . __

_ . __

_.1_
3

Factory COSI
_,___.__ __._ __.__

_.._ __.__

__.._

_,___ _

MiJc,

from factory

Market area of
shirt factory

The market area of the sh irt factory is the area over which the nct cost of a factory shirt (production time
plus travel time) is lcss than the production time of a homcmadc shirt ( 1 hour).

26

Part 1 Market Forces in the Development of Cities

measures the net price of shirts, the sum of the factory price (0.25 loaf) and travel time
to the factory. The horizontal axis measures the distance to the factory in miles. If
walking time is eight miles per hour (four round-trip miles per hour), the factory will
underprice homemade shirts for residents within three miles of the factory (within
0.75 hour walking time). Therefore, the factory's market area is a circle with a radius
of three miles.

A Factory City
A small urban area will develop around the shirt factory. The shirt workers will live
near the factory to economize on commuting costs, and will bid up the price of land
near the factory. As the price of land increases, workers will economize on land
by occupying smaller lots. In other words, the popuiation density around the shirt
factory will be higher than the population density in the rest of the region. A city is
defined as a place with a relatively high population density, so the factory causes the
development of a small factory city.
The factory city develops because two conditions are satisfied. First, agricultural
productivity is high enough that workers outside the city can generate enough food
to feed themselves and have enough left over to feed the shirt workers in the city.
Second, scaie economies are large relative to travel costs, so the shirt factory can
underprice homemade shirts, at least for people living near the factory.

Limits to City Size: Freight Cost and the Railroad

The popuiation of the city is determined by the number of factory workers, which
in turn depends on the total output of the factory. For a given level of economies of
scale, the size of the city is limited by the cost of moving output from the factory to
consumers in the region. In our model, the consumer incurs these freight costs by
traveling between the home and the factory, but the same logic would be applicable
if the firm were responsible for freight costs. The cost of transporting goods limits
the ability of the factory to exploit economies of scale in production.
To illustrate the notion that freight cost is a limit on city size, consider the effect
of increasing the speed of travel within the region. Suppose the travel speed doubles
to 16 miles per hour (eight round trip miles per hour). Recall that the factory can
underprice home production if the travel time is less than 0.75 hour. Therefore, with
a travel speed of 16 miles per hour, the factory can underprice home production over
a six-mile radius. In other words, a doubling of travel speed would double the radius
of the factory's market area. A doubling of the radius will increase the output of the
factory, increasing the factory's workforce and the population of the factory city. In
general, a decrease in freight cost allows the factory to more fully exploit economies
of scale, increasing city size.
During the industrial revolution, innovations in intercity transportation contributed to specialization, trade, and urbanization. The railroad decreased the cost of
moving goods between regions, decreasing the delivered price of both agricultural
and factory goods. Before the railroad linked eastern cities with the western parts

Chapter 2

27

Why Do Cities Exist?

of the United States, a large fraction of the food consumed in New England was
produced by the region's farmers . Similarly, a large fraction of the goods consumed
in the West (e.g., shoes) was produced by local craftsmen. The railroad cut freight
costs, so eastern factories could underprice western craftsmen and western farmers
could underprice eastern farmers. As a result, both regions specialized to a greater
extent and trade increased. The increase in the output of factories in New England
increased the size of its factory cities.

Limits to City Size: Scale Economies and the Sewing Machine

The other limit to the size of the factory city is the extent of scale economies in
production. As economies of scale become more powerful, the cost of factory production decreases relative to the cost of home production, and the market area of the
factory increases, increasing the size of factory cities.
The sewing machine, which was developed in the middle of the nineteenth
century, increased scale economies in the making of clothing and contributed to
the development of cities. Around the beginning of the nineteenth century, about
four-fifths of the clothing worn in the United States was hand-sewn in the home for
members of the household. The other fifth was hand-sewn by tailors. The sewing
machine allowed factory producers to underprice home producers, and by 1890 ninetenths of U.S. clothing was being made in factories. As clothing factories sprang up
in the United States, new cities developed around the factories.
The sewing machine also contributed to the development of U.S. cities around
shoe factories. Before 1700, most shoes were produced in the home or the local
village. The cost of transportation was so high that local production was efficient.
Over time, transportation costs decreased, allowing the exploitation of comparative advantage in shoe production. The putting-out system was implemented in the
l 700s: Shoe producers distributed raw materials to cottage workers, collected their
output, and finished the shoes in a central shop. As new shoemaking machines were
developed, the number of operations performed in the central shops increased. The
McKay sewing machine mechanized the process of sewing the soles to the uppers,
increasing scale economies in shoe production to the point that the central shops
became genuine factories. Cities developed around the new shoe factories.

LIMITS TO CITY SIZE: COMMUTING COSTS

Up to this poi nt, we have implicitly assumed that the wage paid to factory workers
is independent of city size. Each worker is paid one Ioaf of bread per hour of factory
work, regardless of the size of the city. In fact, the wage paid to factory workers will
increase as the city grows because bigger cities have longer commuting times. The
factory must compensate workers for longer commutes, so the wage will increase
as the city grows. As the wage increases, so does the cost of factory shirts relative
to the cost of homemade shirts.

28

Part 1

Markcl Forces in che Developmem ofCicics

TABLE 2-3 Commuting Time, Wages, and Prices

Number of Workers

Commute Time

Work Time

Hourly Wage

100
20,000

Ohours

8 hours

4 hours

4 hours

1 loaf per hour

2 loaves per hour

Wages Increase with City Size

To illustrate the effects of commuting costs on wages and the price of factory shirts,
considera factory city where each worker has eght hours per day to divide between
commuting and factory work. Each hour spent commuting decreases work time by
one hour. To be indifferent between producing bread at home and being employed
in the factory (involving both commute and work times), the worker must be paid
eight loaves of bread for each day of work and commuting.
We can use the simple example shown in Table 2- 3 to show why wages increase
with city size. Suppose that in a small city of 100 workers, commuting time is zero:
every worker lives within a short walk ofthe shirt factory. Each worker spends eight
hours in the factory and earns eight loaves per day, which translates into one loaf
per hour of factory work. At the other extreme, suppose that in a city with 20,000
workers, cornmute time is four hours per day, leaving only four hours for factory
work. To keep the worker indifferent between factory work and home production
of bread, the firm must still pay the worker eight loaves for a day of working and
commuting. On an hourly basis, the wage is now two loaves of bread per hour of
factory work (eight loavcs divided by four hours). In other words, because the larger
city has commuting cost, it has a higher hourly wage.
Figure 2-3 shows the rclationship between city size and wages, using the two
extremes shown in Table 2-3. The hourly wage rises from one loaf per hour in the
small city to two loaves per hour in the city with 20,000 workers.
What are the implications of higher wages for the shirt producer and the factory
city? The higher the wage, the higher the production cost for factory shirts and thc
higher the price of factory shirts. Recall that the market area ofthe factory is defined
as the area over which the net price of factory shirts (the factory price plus travel
costs incurred by the shirt buyer) is less than the cost of homemade shirts. As a
city grows, rising wages will raise the factory price of shirts relative to the cost of
homemade shirts. In other words, higher commuting costs will limit the market area
of the factory and the s ize of the city.

Decrease in Commuting Cost and the Boston Experience

Because commuting costs limit city size, a decrease in the unit cost of commuting
will cause a city to grow. Suppose the city's commuting speed were to double. In
Table 2-3, the commute time associated wth a city of20,000 workers would be cut
in half, reducing workers' commuting time, wages, the cost per shirt, and the price
of factory shirts. As the factory price decreases relative to the cost of homemade
shirts, the market area of the factory will increase, increasing the number of factory
workers and the size of the city.

Chapter 2

29

Why Do Cities Exist?

FIGURE 2-3 The Wage lncrcases with City Size

Wage (loa ves per hour)
2
'O

fil

.D
._

<;,

">

"

Cl)

20
Number of workcrs (thousands)
The
incrcases with the size of the city"s workforcc because lhc largcr the workforcc. thc longer the
com muting distance for workers.

The city of Boston provides a good example of the effects of changes in transit
technology on city size. One rule of thumb is that a city should be small enough
that the typical resident can travel from the edge of the city to the city center in an
hour. In 1850, Boston was a "walking" city with a radius of about two miles. In the
I 860s, the horse-powered railroad (horses pulling cars along rails) was introduced,
and the radius of the city increased to 2.5 miles in 1872 and 4.0 miles in 1887. By
the l 890s, the horse railroad was replaced by the electric trolley, which traveled at
twice the speed and carried three times as many passengers. As a result, the radius
of the city increased to about six miles. In the 40 years during which walking was
replaced by the trolley, the radius of the city tripled and the Jand area increased
ninefold.

HISTORICAL INSIGHTS: A BRIEF HISTORY

OF WESTERN URBANIZATION
We can use the concepts developed in this chapter to provide sorne insights into
the historical development of cities in the Western world. We've seen that trading
cities develop when comparative advantage is combined with scale economies in
transportation, and factory cities develop when there are scale economies in production. This part of the chapter takes a historical perspective, discussing how changes
in technology caused cities to grow and shrink, and eventually caused urbanization
around the world.

30

Part 1 Market Forces in the Development of Cities

The First Cities

The first cities developed in the fertile river valleys in the Near East around 3000
B.C. The city-states that developed in the Mesopotamia Valley included Eiridu, Ur,
Lagash, and Kish. Ur was the largest of these cities, with a land area of about 150
acres and a population of about 25,000. In 2000 B.C., the city of Babylon had a
population of about 50,000. These cities developed shortly after a number of agricultura! breakthroughs generated a surplus of food, allowing sorne people to pursue
nonagricultural activities in cities. Among the innovations were the domestication

of grain, the development of irrigation systems, and the plow (replacing the hoe).
According to Davis ( 1976), between 50 and 150 farmers were required to support a
single city inhabitant.
Why did the first cities develop? There is sorne uncertainty about the social
and economic features of early societies, so historians can only speculate about the
origins of cities. Most agree that the first cities served both religious and defensive
purposes. Can the development of defensive and religious cities be explained by the
same factors that explain the development of market-based cities?
Consider first the defensive city. A farmer who generates an agricultura! surplus
will eventually use the surplus, either consuming it himself or trading it for other
goods. In either case, he must store the surplus food for sorne period of time. The
stored food provides a lucrative target for thieves. If there are scale economies in
food storage and protection, farmers may be better off storing their surpluses in a
central storage facility rather than a set of facilities, one for each farmer. The people
working in the fortified storage facility (managers and guards) will Iive near the facility, generating a place with a relatively high population density, a small city. This is
the theory of the defensive city: The first cities developed because of scale economies
in the storage of the agricultura! surplus. Support for the theory comes from archaeologists who uncovered the remains of fortified storage facilities in the first cities.
Consider next the religious city. According to Mumford ( 1961), the development
of the first cities coincided with the development of large-scale religion. Before the
development of cities, most people worshipped in small groups, either in the home
or in the local village. Around the time that the first cities developed, the local earth
gods were replaced by celestial gods, who may have demanded worship on a grander
scale. If adoration and supplication were considered more effective on a large scale,
a doubling of the size of the shrine would more than double the religious output.
The small shrines in homes and villages were replaced by large temples at central
locations, which employed chieftains, priests, and religious workers, and caused the
development of a place with relatively high population density, a city. This is the
theory of the religious city: The earliest cities developed because of scale economies
in the provision of religion. Support for the theory comes from archaeologists who
uncovered the remains of large temples in the first cities.
The most prominent feature of the early city was a large temple at the city
center, a site for worship and the storage of the agricultura! surplus. Which carne
first, the central storage faci lity or centralized religion? Perhaps the central storage
facility made worship in the central temple more convenient, causing the switch to

Chapter 2

Why Do Cities Exist?

31

centralized re ligion. Alternatively, the development of a large temple could have

provided a convenient and defensible storage facility for the agricultura! surplus. In
other words, there were economies of scope in the provision of religion and defense:
the t-wo services were provided more efficiently if they were provided together. A
third possibility is that the local chieftains used centralized religion as a subterfuge
to extract the agricultura! surplus from local farmers.
The military played a major role in the early cities. The developmcnt of cities increased the frequency and severity ofhuman conftict for two reasons. First, the cities
worshipped different gods and fought wars to settle religious disputes. Second. the
urban societies accumulated wealth, providing lucrative targets that encouraged materialistic wars. Although c ities encouraged aggressive behavior, they also provided
the most effective defense against aggression. Until the dcvelopment of gunpowder
in the fourteenth century, the most effective defensive maneuver was a large but simple wall. In addition, a city contained enough people to defend itself against attack
from large forces. Once the simple wall was built, there was safety in numbers.

Greek and Roman Cities

The next stage of western urbanization occurred in Greece. In 500 B.C. there were
hundreds of independent city-states, ranging in population from a few hundred to
tens of thousands. Athens was the largest, with a population of about 150,000, and
Sparta hada population of about 40,000. In contrast with earlier cities, which were
controlled by chieftain-priests, most Greek c ities were run by their citizens, using
public assemblies to make policy.
Athens was a market city, with trading activity centered in the Agora. Early in its
history, the city established independent colonies and traded its household crafts and
olive products for food and raw materials from the colonies. Trade was facilitated by
the stamping of gold and si lver coins in the seventh century B.C. In this early period,
Athens fed itself through voluntary trade with other areas.
The Athenian empire developed in the aftermath of the successful war against
Persia in the fifth century B.C. After the Greek city-states repelled thc Pcrsian invasion, they formcd the Delian League to carry the war into Asia Minor. By the end of
the successful campaign, Athens had assumed complete control ofthe league, dictating policy to the other c ity-states. Athens took control of the treasury, transforming
the voluntary contributions of member city-states into payments of tribute to Athens.
The system of homage and crbute led ro the Peloponnesian War becween the Athenian
Empire and Sparta (431 to 404 B.C.). The war ended in 404 whe n Athens renounced
control over its empire and demolished its defens ive walls. Athens ncvcr regained
its former power. Evenrually, Philip of Macedonia was a ble to take advantage of the
weakened city-states and expanded his kingdom to include most of Greece.
The next stage of western urban development occurred under the Roman Empire.
By the third century A.O., Ro me hada population exceeding one mili ion. The Romans
set up colonies to the north and west, establishing colonial cities throug hout Europe.
Rome fed its large population with a combination of trade and tribute, with tribute
playing a relatively large role.

32

Part 1 Market Forces in the Development of Cities

The Roman cities were eventually overrun by marauders from rural areas. According to Hohenberg and Lees (1985), the Roman economy emphasized the collection of the agricultura! surplus and neglected production activity. lnstead of exchanging urban goods for agricultura! products, Rome used conquest and tribute to
feed its population. In the fourth and fifth centuries, German tribes invaded from
the north, disrupting the Roman collection system. It appears that there was little
interest outside of Rome in restoring the "trade" routes, so the losses from successive invasions were cumulative. lf Rome had relied to a greater extent on voluntary
exchange, the colonies might have been more interested in maintaining the exchange network, and the Western empire might have recovered from the Germanic
raid s.
What are the lessons from the rise and fall of Athens and Rome? Early in
its history, Athens engaged in voluntary trade with other areas, exchanging urban
goods for food from the countryside. The city thrived under this system of voluntary
exchange. T he Athenians eventually switched to a system of conquest and tribute,
resulting in war and the decline of the city. Mumford (1961) suggests that the city
of Rome should have been called "Parasitopolis" to indicate the extent to which its
population lived off the labors of outsiders. The decline of Rome was caused in part
by the disruption of its collection system by the Germanic raids. Perhaps the lesson
is that cities based on voluntary exchange are viable, but cities based on coercive
transfer payments are not.

Feudal Cities
In the first few centuries following the fall of the Roman Empire, cities in the West
declined. The Islamic conquest disrupted trading on the Mediterranean, causing the
decline of many port cities. Waves of marauding barbarians continued to sweep
across Europe, making travel and trade dangerous. People sought safety inside city
walls, where, once again there was safety in numbers.
The feudal economy of the eleventh through the fourteenth centuries was based
on manorial estates and small walled cities. On the manor, the lord inherited his
serfs, who worked the lord's land and served in the military in exchange for the use
of a small plot of land. In the small towns, workers produced handicrafts (cloth,
leather goods, metal goods), which they exchanged for the agricultura! surplus of
the manor. Cities in the feudal era were small and numerous. In the eleventh century,
London was the largest city in England, with a population of only 16,000. There
were severa! other English cities with populations of around 5,000. The largest of
the many German cities had a population of no more than 40,000.
The largest cities served the Byzantine Empire and the Muslim areas of Spain.
Venice was one of the few large cities beyond the Byzantine and Muslim areas, but it
depended heavily on trade with the Eastern empire. During the eleventh and twelfth
centuries, the Ttalian city-states forged agreements with the Byzantine and Islamic
rulers for trade with North Africa and the East. The Europeans traded wood, iron,
grain, wine, and wool cloth for medicines, dyes, linen, cotton, leather, and precious
metals. T he increased trade contributed to the growth of Ven ice, Genoa, and Pisa.

Chaptcr 2

Why Do Cities Exist?

33

Between the eleventh and fourteenth centuries, the frequency of barbarian invasions decreased, and the small defensive cities gradually became market cities. The
medieval cities specialized in commerce and handicrafts, and thus earned-rather
than robbed- the agricultura! surplus of their hinterlands. A small merchant class
developed, and marketplaces were established just outside the city walls. The me rchants were protected from plunder by the establishment of weekly market days:
Once a week, theft was outlawed in places marked by the market c ross. The market
peace was enforced by local chieftains, special courts with jurisdiction over traders,
and thc church. The markets ftourished, and the cty walls were extended to include
the marketplaces. The urban market was primarily a place for the exchange of local
agriculture and handicrafts. The producers of handicrafts made up a large fraction
of the city 's workforce.
Hohenberg and Lees ( 1985) use Leicester, in the East Midlands of England, as
an example of a medieval city in the fourteenth century. The city was surrounded
by walls on three sides and a river on the fourth. The town ditch was just outside
the wall. The city was a regional marketplace, serving as a commercial center for
the surrounding county. The city produced staples such as beer and bread for local consumption and produced woolen cloth for export. Occupations in the city
included butchers, shoemake rs, tailors, mercers, weavers, and bakers. Over half of
the city's workers were employed in manufacturing, with the other half employed as
food makers (25 percent), traders and merchants ( 1O percent), bui lders (5 percent),
and other occupations. The merchant guild controlled most economic activity in
the city.
According to Davis ( 1976), the first market-based cities developed for two reasons. First, power in the feudal system was decentralized. Unlike the Greek and
Roman cities, medieval cities could not simply domnate their hinterlands and demand tribute, but had to produce something in exchange for agricultura! goods.
Second, agricultura! productivity was relatively low, so a city could not survive on
the output of its immediate hinterland, but had to trade with a relatively large area.
As a result, the city had to develop products that could compete with homemade
products in its hinterland and products produced in other cities.
Competition among the medieval cities caused innovations in production and
commerce. Urban producers developed new production techniques, allowing them
to underprice their competitors. Cities invested in secular education as a means of
promoting literacy and developing commercial ski lis. These earl y efforts to improve
the techniques of production and commerce set the stage for the industrial revolution
of the eighteenth and nineteenth centuries.

Mercantile Cities
Starting in the fifteenth century, large mercantile cities developed in Europe. One
factor in this development was the transfer of power from a large number of feudal
lords to a relatively small number of princes, queens, and kings. The shift in power
was caused in large part by military advances that rendered the traditional feudal
defense maneuvers obsolete.

34

Part 1 Market Forces in the Development of Cities

Innovations in warmaking increased the seriousness and scale of conflict. The

feudal lord used his serfs as part-time warriors. If these warriors could not defeat
the attackers in the field, the feudal lord could always hunkerdown behind his castle
walls to wait out a siege. The professional army of the fifteenth century combined
infantry (armed with pikes, crossbows, and muskets) with siege cannons and cavalry.
The professional soldiers, with their sophisticated weapons, usually defeated the
feudal lord's part-timers in the field. When the lord retreated to his castle, the siege
cannons blew holes in the castle walls. The professional armies defeated the feudal
lords, centralizing power in the hands of princes, queens, and kings. In response,
mercantile cities built intricate fortifications and also hired professional soldiers.
The larger cities were able to exploit the increased scale economies in defense.
The centralization of power caused the centralization of administrative and military functions in royal cities. After the sixteenth century, the most rapidly growing
cities were the ones that harbored a royal court. In a short period of time, more
than a dozen cities grew to a size attained by only a few medieval cities: London
had 250,000 people, Naples 240,000, Milan 200,000, and Paris 180,000; cities with
around 100,000 inhabitants included Rome, Lis bon, Palenno, Seville, Antwerp, and
Amsterdam.
A second factor in the growth of mercantile cities was long-distance trade. The
consolidation of power eliminated local tariffs imposed by feudal lords and trade
increased. The development of ocean travel led to exploration and the discovery of
new markets. Cities developed along trade routes and at transshipment points. While
cities with river and seaports ftourished (Naples, Palermo, Lisbon, and Liverpool),
inland cities like Florence declined.

Urbanization during the Industrial Revolution

Despite the rapid spread of cities between 3000 B.C. and 1800 A.O., the world continued to be predominantly rural. Urbanization was limited by the relatively low
productivity of agriculture, the high costs of transporting goods (which limited the
volume of trade), and the relatively small advantages of centralized production. Until the early part of the nineteenth century, the fraction of the world's population
living in cities was only about 3 percent. Between 1800 and 1970, the percentage
of the population in urban areas increased to 39 percent. In the United States, the
percentage ofthe population in urban areas increased from 6 percent in 1800 to over
75 percent in 1990.
The rapid urbanization of the last two centuries was caused by the industrial
revolution, which started in the nineteenth century. 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. Between 1700 and
1900, .\1anchester, Birmingham, Glasgow, and Liverpool grew from tiny towns into
giant industrial cities. The innovations of the industrial revolution can be divided
into four areas: agriculture, manufacturing, transportation, and construction.
The rapid urbanization of the industrial revolution was made possible by innovations that increased agricultura! productivity. Farmers substituted machinery for

Chap1er 2

Why Do Cities Exis1?

35

muscle power and simple tools, increasing the output per farmer. For example, using
a hor e-drawn reaper, two people could harvest the same amount of grain as eight
people using tradtonal harvesting methods. In addition, the development of agricultura! science led to innovations in plantng, growing, harvestng, and processing.
As produclivity increased, laborers were freed from food-raising responsibilties, allowing them to pursue other activities. In the United States, the share of employment
in agriculture decreased from 69 percent in 1840 to 2.8 percent in 1988.
Perhaps the most visible part of the industrial revolution involved innovations
in manufacturing. Ncw machines, made of iron instead of wood; were developed for
the production of most goods. Manual production by skilled artisans was replaced by
mechanized production using interchangeable parts, specialized labor, and steampowered machines. Output per worker rose, and scale economies in production
increased. Mass production decreased the relative cost of factory goods, causing the
centralization of production and employment in large industrial cities.
Innovations in intercity transportation contributed to industrialization and urbanization. The steamship and the railroad decreased the costs of moving goods between
cities, decreasing the delivered price of factory goods. Production became more centralized, and factory cities grew. The new transportation modes also decreased the
costs of moving agricultura! goods, allowing greater regional specialization in agriculture. Agricultura! regions were better able to exploit their comparative advantages,
so agricultura! productivity increased. Trade increased because the railroad allowed
both regions to exploit their comparative advantages.
Innovations in construction methods also increased city sizes. The first skyscraper, a 10-story building that housed the Home lnsurance Company, appeared
in 1885 in Chicago. T he building was revolutionary because its frame was made
of steel instead of bricks. Because the steel frame was relatively light, the building
could be taller than the traditional brick building. The development of the elevator
decreased intrabuilding travel costs in tall buildings, increasing the feasibility ofthe
skyscraper. The skyscraper increased the intensity of land use, increasing the city's
productive capacity and its feasible population.

Urbanization in the United States

Figure 2-4 shows the trend in U.S. urbanization from 1800 to 1990. In 1800, only
about 6 percent of the population lived in cities. The share of population in cities
increased to 15 percent by 1850, 40 percent by 1900, 64 percent by 1950, and
75 percent by 1990.
The industrial revolution caused dramatic growth in U.S. cities. Between 1850
and 1890, the populations of New York and Boston more than tripled; the population of Baltimore more than doubled; and the population of Philadelphia increased
more than eightfold. Further west, on average, the populations of Chicago, Detroit,
Cleveland, Pittsburgh, and Los Angeles increased J8-fold between 1850 and 1890.
Lurking behind these changes were large increases in urban manufacturing activity.
The share of employment in manufacruring more than doubled in most of these
cities, from about 1Opercent of total employment to about 20 percent.

36

Part 1 Market Forces in the Developrnent of Ci tes

FIGURE 2-4 Percent of U.S. Population Living in Urban Areas, 1800-1990

80

75
70
65

60

"'"'
"'e
-e"'::>
e

55

50
45
40
35

;:
O)

30
25
20
15
10
5

1800

1820

1840

1860

1880

1900

1920

1940

1960

1980

2000

Y car

SUMMARY
l. Employment opportunities are concentrated in cities because sorne activities are
subject to economies of scale.
2. A trading city will develop if [a] the differences in productivity underlying
comparative advantage are large relative to transportation costs and [b] there
are scale economies in transportation.
3. A factory city will develop if scale economies in production are Jarge relative

to transportation costs.
4. City size is limited by the cost of transporting goods (freight cost) and the cost
of transporting workers within the city (commuting cost).
S. The first cities developed for defensive and religious reasons.
6. T he centraJization of powerduring the mercantile period caused the development
of administrative cities and reduced trade barriers. Combined with effi cient
ocean traveJ, this resulted in the development of trading cities.
7. The rapid urbanization in the nineteenth and twentieth centuries was caused
by the industrial revolution and the associated innovations in agriculture, transportation, and manufacturing.

Chapter 2

Why Do

37

Exist?

EXERCISES ANO DISCUSSION QUESTIONS

1. The table below summarizes the productivity of workers in bread and shirt production in two parts of a region.

2.

3.

4.

S.

Output per Hour

Opportunity Cost

East

East

Wesl

Bread

Shirts

West

a. Complete the table by providing the opportunity costs of producing bread

and shirts in the East and the West. For which good does the East have a
comparative advantage? What about the West?
b. Assume that transport costs are zero and that the exchange rate is two shirts
for one loaf. If a western household switches one hour from shirt production
to bread production and exchanges all thc additional bread for shirts, will the
household be better off'?
c. Suppose that the time required to execute the trade in (b) is one hour. Is trade
still beneficia!? At what transaction cost (time per trade) would the net gain
from trade be zero?
d. Under what cond itions will the differences in labor productivity cause the
development of cities?
Considera region that has a single trading city, a city that developed as a result
of comparative advantage in the production of a homogeneous good (shirts) and
scale economies in transportation. The shirts produced by different households
are perfect substitutes, and communication between households is costless. Suppose that a matter transmitter is introduced into the region. The transmitter at no
cost transpo1ts goods, but cannot be used to transport people. The transmitter is
cbeap enough that every household can purchase one ata relatively low cost.
a. Will the matter transmi11crcause the trading city to grow, shrink, ordisappear?
b. How would your answcr to (a) changc if shirts are not homogcneous (i.e.,
shirts from different households are not perfect substitutes)?
Consider a country with two regions that are separated by a mountain range.
Initially, there are no cities in the country. Suppose that a tunnel is bored through
the mountain, decreasing travel costs between the two regions. Under what
conditions will the tunnel cause the development of trading cities?
Considera region that has a single factory city, a city thatdeveloped as a rcsult of
scale economies in production. lt is a walking region: People walk to work and
to purchase consumer goods. Suppose pump sneakers are introduced (selling
at the same price as traditional shoes), doubling walking speeds. Will pump
sneakers cause the factory city to grow, shrink, or disappear?
Region F has a single factory city (a city that devcloped as a rcsult of scale
economies in production). Suppose that a matter transmitter is introduced into
the region. The transmitter can costlessly transport goods, but cannot be used

38

Part 1 Market Forces in the Development of Cities

6.

7.

8.

9.
10.
11.

to transport people. The transmitter is cheap enough that every household can
purchase one ata relatively low cost. Will the matter transmitter cause the factory
city to grow, shrink, or disappear?
Considera region that produces lemons and ice and consumes lemonade (lemons
and ice together). Ali resources are distributed uniformly throughout the region,
and ali people are equally productive in producing lemons and ice. There are
scale economies in the production of ice, causing the development of an ice
factory and a factory city. Suppose that a small refrigerator is introduced and
imported into the region, providing an alternative to the ice purchased from ice
factories. Explain the effects of the refrigerator on (a) the market area of the ice
factory and (b) the size of the city surrounding the ice factory.
Consider Retireland, a region where most residents are retired. Residents of the
region consume a single good (food), which is imported from another region
and sold in vending machines. Wi ll there be any cities in Retireland? If so, how
will they differ from cities in regions where most people work?
Using the example in Table 2-3 as a starting point, for each of the following
events, depict graphically the effect of each event on the relationship between
wages and city size (shown in Figure 2- 3). Then discuss the implications of the
event for the size of the factory city. (a) The work <lay shrinks to 6 hours (work
time plus commute time is six hours). (b) Commuting speed doubles. (e) Agricultura! productivity (bread production per hour) doubles to two loaves per hour.
Critically appraise: "lnnovation in agriculture during the industrial revolution
was a necessary, but not sufficient, condition for the urbanization of society."
Sorne societies never developed any cities. Where did these societies develop?
How did they differ from the societies that developed cities?
The Romans auctioned off the rights to tax their colonies to commercial taxcollecting agencies. In other words, the Romans sold franchises to tax collectors.
Might this auction scheme ha ve conttibuted to the decline of Rome? If you were
in charge of the franch ising system, what restrictions would you place on the
tax collectors?

REFERENCES
1. Davis, Kingsley. "Urbanization." In The Urban Economy, ed. Harold Hochman.
New York: W. W. Norton, 1976.

2. Hohenberg, Paul M., and Lynn H. Lees. The Making of Urban Europe 10001950. Cambridge, Mass.: Harvard University Press, 1985. Discusses the reasons
for the urbanization of Europe.
3. Mumford, Lewis. The City in History. New York: Harcourt Brace Jovanovich,
1961.