Professor: Keren Mertens Horn Office: Wheatley 5-78B Office Hours: TR 2:30-4:00 pm ECONOMICS OF THE METROPOLITAN AREA 212G, SPRING 2013

WHY DO CITIES EXIST?  US Cities:  In 2010, 84% of the U.S. population lived in urban areas, up from 62% in 1960 and just 6% in  Internationally:  Today roughly half of the world’s population lives in urban areas, up from 30% in 1950  As countries develop they tend to become more urbanized.  In developed world roughly 75% of the population lives in urban areas  In less developed countries roughly 45% live in cities  Cities are getting larger  Over last 30 years NYC grew at an annual rate of about 0.5%, Mumbai by 3.1%, Dhaka by 5.6%  Given that the world’s population continues to urbanize and cities continue to grow, can we explain why this happens?

 Most important economies of scale for urban economics is called Agglomeration  An agglomeration economy exists when production is cheaper because more activity is going on nearby  Two types of agglomeration economies:  Localization Economies  Economies of scale that arise from have many firms in the same industry locate near one another  Urbanization Economies  Economies of scale that arise from having many people located together, regardless of the industry in which they work.  Sources of agglomeration economies? INCREASING RETURNS TO SCALE!

 Why do cities facilitate specialization?  Cities provide sufficient demand to support a large supply of specialized services and organizations  Adam Smith “The division of labor is limited by the extent of the market”  Why does specialization aid productivity?  It makes production cheaper and smoother  Thinking about the business of curing cancer. In a large city, such as Boston, we have many doctors that specialize in curing particular types of cancer. Then within specialties, there are subspecialties. A dermatologist can specialize in Mohs, which has a very high cure rate (98%) and can minimize the amount of skin that needs to be removed.  Specialization can arise from both Localization Economies and Urbanization Economies  Chicago stockyards example of localization  Organization of ultra-marathon runners example of urbanization SPECIALIZATION

 “Economies of scale that arise because larger organizations have less need for down-time between demands on their services”  Again if we think about curing cancer:  Small cities there are times when no one will be in need of a doctor who specializes in Mohs surgery.  Large city more likely there will always be a need for a doctor who specializes in Mohs, and many other specialties.  Demand Smoothing can arise from both Localization Economies and Urbanization Economies  An advertising agency that specializes in non profit campaigns will have much less down time in Washington DC than in Topeka Kansas.  Organization of ultra-marathon runners example of urbanization DEMAND SMOOTHING

 What are intermediate inputs?  Things used to make other things – Screens used to make Televisions, Engines used for Cars.  Interpreted more broadly a night at the Opera could be an intermediate input as it is used to make the lives of city residents more pleasant.  There are economies of scale associated with having all these ‘intermediate inputs’ located nearby.  It is cheaper to make TVs when the screens don’t have to be shipped long distances (ex of Localization Economies)  Firms benefit from employing people in places that already have sewers, childcare, restaurants and theater (ex of Urbanization Economies) INTERMEDIATE INPUT ECONOMIES OF SCALE

 What are externalities?  “An uncompensated impact of one person’s actions on the well-being of a bystander.” (Mankiw)  “A cost (benefit) that is not borne directly by the person who decides about incurring it.” (O’Flaherty)  Ex/A cup of tea can have a positive externality, if my good mood as a result of drinking the tea during class spreads to all of you (or helps me communicate this material in a clear fashion).  Knowledge Spillovers is key positive externality that arises from density.  Firms in the same industry can learn from each other if they are located nearby and improve their production techniques (ex/Silicon Valley)  Firms in different industries can take techniques used in one industry and apply to a different industry. (ex/If a bookstore comes up with an innovating marketing technique, and real estate agent next door could learn from them and improve their business) EXTERNALITIES

 Takes less time and energy to find what you are looking for!  Employers can more easily find exactly the right person for a job. (ex/Global Fraud Analyst)  Consumers can more easily find exactly the product they are looking for in a large city (ex/A bilingual day care center)  Implications:  Businesses that involve physical searching should be located in cities (ex/Diamond District in NYC)  Lower search costs lead to better matches (Less likely to settle or pay more for a product)  Avoids ex post opportunism – when one party has to make an investment that is worthless without the other party (a new Opera House becomes worthless if the city no longer has an Opera) LOWER SEARCH COSTS

 These are theories crafted by economists to explain why cities exist, but are they true?  How could we test them?  Evidence from Economic Research on Agglomeration  Wages are higher in cities  Glied (1997) in 1994 per capita personal income was 35% higher in metropolitan areas than in non-metropolitan areas  Urban wage premium increases over time  Glaeser and Mare (1994)  Urban wage premium does not go away when a worker leaves the city  Glaeser and Mare (1994) EVIDENCE?

 About 45% of US new product innovations occur in 4 metropolitan areas – New York, San Francisco, Boston and Los Angeles (Feldman and Audretsch, 1999)  Why are cities hotbeds of innovation?  Interaction and Diversity – lots of people from lots of backgrounds coming together  New ideas harder to communicate over long distances – inventions can spur further inventions  Easier to bring innovation to market – faster you can find your intermediate inputs the faster you can turn your idea into a reality  Job turnover is high – less risk of leaving a job to try and turn an idea into a business INNOVATION

 Are some negative consequences associated with clustering:  Congestion  Pollution  Disease  Crime  High Rents  If not addressed these negative externalities can wipe out all the positive things that cities promise. NEGATIVE EXTERNALITIES

 In the age of the internet and telecommunications, do cities still matter?  Many believe technology provides a fundamental threat to the existence of cities  Question is whether electronic communications are complements or substitutes of face-to-face communications?  Complements – two goods for which an increase in the price of one leads to a decrease in the demand for another (consumed together like milk and coffee)  Substitutes – two goods for which an increase in the price of one leads to an increase in the demand for the other (one takes the place of the other like coffee or tea)  As transportation costs continue to decline, internet shopping continues to grow, and electronic communication becomes easier will cities become less or more important? DO WE STILL NEED CITIES?

 AGGLOMERATION  An agglomeration economy exists when production is cheaper because more activity is going on nearby  LOCALIZATION ECONOMIES: Economies of scale that arise from have many firms in the same industry locate near one another  URBANIZATION ECONOMIES: Economies of scale that arise from having many people located together, regardless of the industry in which they work.  EXTERNALITIES  An uncompensated impact of one person’s actions on the well-being of a bystander.  COMPLEMENTS  Two goods for which an increase in the price of one leads to a decrease in the demand for another (consumed together like milk and coffee)  SUBSTITUTES  Two goods for which an increase in the price of one leads to an increase in the demand for the other (one takes the place of the other like coffee or tea) REVIEW OF ECONOMIC CONCEPTS