Why Do Cities Exist?

Economics 312
Martin Farnham
 Conditions under which no cities
would exist (consider a 2-good world)
• Equal productivity of resources (no
comparative advantage)
• Constant returns to scale.
– In exchange (unit cost of each transaction is
same, regardless of quantity transacted)
– In production (unit cost of each unit produced is
same, regardless of quantity produced)
• Together, these eliminate need for
specialization and trade.
– Everyone sits on their own piece of land making
(and consuming) bread and shirts.
– Population distributes itself evenly across space.
 Why Do Cities Exist?
• Comparative advantage plus economies of
scale in exchange==>trading cities
– Gains from trade cause resources to be put to
specialized use
– Economies of scale in exchange causes trading
firms to act as intermediary between buyers and
sellers (otherwise buyers seek sellers directly)
• Trading firms (& workers) will tend to concentrate in
areas that facilitate collection and distribution of goods
• Comparative advantage plus economies of
scale in production==>factory cities
– Economies of scale in production means that it
makes sense to concentrate resources (in factory)
• Workers will locate nearby
Econ 312--Farnham 3
 Trading Cities
• Cities can serve as a central market place for
regional buyers and sellers or as distribution
centers
• Crossroads, ports, rivers serve as natural
location points for firms seeking to keep
transport costs low.
• Trading firms (distributors) and their
employees will locate near these points
• Rising population drives up land prices
• Residents demand smaller plots of land;
population density rises==>city!
Econ 312--Farnham 4
 Factory Cities

• Location of factory will lead workers to locate

nearby (keeps commuting costs down)
• Workers will bid up price of land, demand
smaller lots==>increase in population density
• Note that gains from scale economies are
partly offset by increased transport costs
imposed on customers
• Factory can economize on transportation
costs by locating near population clusters
(trading cities?)
Econ 312--Farnham 5
 Per unit Per unit
Factory Factory
Production Production
Cost (plus Cost (plus
transport) transport)
Net
Cost Home
(hours) Production
Cost
Per unit Factory
Production Cost
Miles
0 from
Factory
Factory
Market
Area

Econ 312--Farnham 6
 Limits to City Size

• Freight costs
– Decreased transport costs increase radius that
factory can serve competitively==>increases
population of factory workers and city size
– Growth of railroads during Industrial Revolution
increased market size for Eastern manufacturers
and Western farmers==>increased specialization,
and growth of Eastern cities

Econ 312--Farnham 7
 Limits to City Size (cont)

• Economies of Scale in production

– Higher economies of scale increase factory’s
market radius, which increases city size
• Commuting Costs
– Worker wage must account for commuting costs
(or else worker will prefer to produce at home)
– Bigger cities have higher commuting costs, hence
may need to pay higher wages (drives up price of
factory output relative to home output; reduces
market radius of factory)

Econ 312--Farnham 8
 Resource-Oriented Towns

• Living in BC, we’re familiar with towns that

are neither factory nor trading towns
– Tourist towns
– Resource towns
• Logging (and milling)
• Fishing (and canning)
• Mining (and smelting)
• Both of these types of towns exist due to
industries that locate to be near an
immoveable input (forests, good scenery,
fisheries, etc.)
Econ 312--Farnham 9
 Resource-Oriented Towns

• Cities have risen and fallen for reasons

of resource location throughout history
– Mining booms (e.g. California, Australia,
Yukon boom--bust towns)
– Port Alice, BC (logging, milling)
– Fort McMurray, AB (oil sands)
– Kansas City meat processors (near cattle
herds; affected by rail line location)
– Whistler, BC (where ski hill is “resource”)
Econ 312--Farnham 10
 Resource-Oriented Towns
• Why are some resources “immobile”?
– Fish could be transported inland for canning, but
refrigerated transport is costly; easier to can fish
near docks.
– Logs can be transported on trucks, but this is
costly. Best to truck short distances to mills
located near forests.
• Log exporting has become more popular as transport
costs fall and trade opens up cheap foreign labour as
alternative to (relatively) expensive local labour
– Iron ore is very heavy relative to finished iron.
• Better to smelt the iron close to the mine, and then ship
the finished product.
Econ 312--Farnham 11
In Some Cases Resources are Best
Processed Near Final Market
• Sand is an important input into glass
– Should glass be manufactured near sand
pits, or near final consumer?
• Final consumer. Because glass is fragile and
benefits from minimizing transport distances.
– Should oil be turned into gasoline near oil
fields or near final consumer?
• Much refining happens near final consumer,
because gas is more volatile (and therefore
dangerous/expensive to transport) than oil.
Econ 312--Farnham 12
 As Technology Changes, so may
Location Criteria
• Mills used to locate on streams so power
wheel could be turned by force of water.
– Rise of coal power lessened the need to locate on
a stream
– Also increased relative desirability of transporting
goods (including the input coal) by steamship (as
opposed to horse/cart and rail)
– Rise of coal-powered energy led firms to move
away from small streams, to large rivers, where
access to steamships (transport of inputs and
outputs) was cheaper.
– Key needed resource changed.
Econ 312--Farnham 13
 Other Firm Location Criteria

• Local taxes
– Low property, income taxes may attract
businesses to certain locations.
• Local services
– Good roads, good schools (to attract educated
workers), etc. may attract firms.
• Note that these two are generally in
opposition (hard to have low taxes and great
services); however, general efficiency of
government may matter.
Econ 312--Farnham 14
 Other Firm Location Criteria

• Proximity to consumers
– Most firms face major transportation cost in
shipping goods to consumer
– Selling through distributors lowers these costs (if
you buy a GM car, you buy it from a dealer, not
directly from a GM plant in Ontario)
– Note that we can show transportation costs on
with either the supply curve or the demand curve.
• i.e. We can think of transport costs as shifting up the
marginal cost curve; or we can think of it shifting down
the marginal willingness-to-pay curve.

Econ 312--Farnham 15