Chapter Two

Market Forces in the

Development of Cities
 Objectives of the chapter
After studying this chapter you will be able
to
Explain economic reasons responsible for
the existence of cities within regions.
Discuss the fundamental reasons for
centralized production and marketing and
explore the implications for the
development of cities.
Appreciate how market-area analysis can
be applied to decision making in the public
sector.
Market Forces for Existence of Cities
Cities exist because individuals are not
self-sufficient.
If each of us produced everything we
consumed and we didn’t want much
company, there would be no need to
live in cities
Most of us live in cities because that is
where most of the jobs are.
Cities also provide a rich mixture of
consumer goods and services, so even
people who are not gainfully employed
Cont…
By living in cities, we achieve a higher
standard of living, but we also must put up
with negative externalities such as more
pollution, crime, noise, and congestion.
This part explores three reasons for the
concentration of jobs in cities. It focuses on
the market forces that generate cities
1. Comparative advantage makes trade
between regions advantageous, and
interregional trade causes the development
of market cities.
 Cont…
2. Internal Scale Economies in
Production allows factories to produce
goods more efficiently than individuals,
and the production of goods in factories
causes the development of industrial
cities.
3. Agglomerative Economies in
Production and Marketing causes
firms to cluster in cities, and this
clustering cause the development of large
cities.
A MODEL OF A RURAL REGION
(REGION WITHOUT CITY)
 A Model of Rural Region
Under what conditions will be there if no
cities in a particular region?
We shall try to find out a model of a region
that has a uniform distribution of population
and hence no cities.
This model provides a set of assumptions
that together prevents development of cities.
When these assumptions are relaxed, cities
will develop.
Let us assume a region in which only two
commodities wheat and wool cloth are
produced and consumed. The regional
economy has following characteristics.
 Cont…
1. Inputs: Land and labor are two inputs.
Land is used to grow wheat and raise
sheep.
Labor spins raw wool into yarn and
weaves the yarn into cloth.
2. Equal productivity: All labor and land
are equally productive.
In one hour, every person can produce
either one-yard of cloth or one bushel of
wheat.
Similarly all land is equally productive
 Cont…
3. No scale economies: Production is
subject to constant returns to scale.
4. Travel time: Trade within this region
is by foot.
No scale economies in transportation.
These assumptions are strong enough to
prevent trade.
Every household in the region will
produce wheat and cloth.
Because all households are equally
productive in producing both goods,
there are no advantages from trade.
 Cont…
Because productivity is independent of the
volume produced, there are no advantages
for centralized production.
Therefore every household in the region is
self-sufficient
The population will be distributed uniformly
throughout the region.
Since a city is defined as a place with a
relatively high density of population, a region
with uniform distribution of population will
have no cities.
Cont…
There are no cities because the model's
assumptions are strong enough to
eliminate the possibility of trade and
centralized production.
 And hence formation of location with
relatively high population density.
Relaxing the comparative Advantage and Urban Development
One factor in the development of cities is
comparative advantage.
Different people possess different abilities
and resources and may want to consume
goods in different proportions
Diverse preferences as well as varied
physical and financial endowments open-up
the possibility of profitable trade
Cont…
People usually find it profitable to trade the
things they possess in large quantities
relative to their tastes or needs in return for
things they want more urgently.
 Because it is virtually impossible for
individuals to provide themselves with all
the consumption requirements of even the
simplest life,
They usually find it profitable to engage in
activities for which they are best suited or
have a comparative advantage in terms of
their natural abilities or resource
Cont…
The principle of comparative advantage asserts that
an individual or a region should specialize in the
production and exchange of the product that it can
produce at lower relative cost.
Illustration
The notion of comparative advantage can be explained
with a simple model of trade between two parts of the
region.
Suppose that the Western half of the region is more
productive than the Eastern half.
The west has an absolute advantage in producing both
wheat and cloth: western residents produce twice as
much wheat per hour and six times as much cloth per
hour.
The differences in productivity could be caused by
Cont…
Output Per Labor Opportunity Cost of
Hour Production

East West East West

Wheat 1 2 1 Cloth 3 Cloth

Cloth 1 6 1 Wheat 1/3 Wheat

Cont…
The notion of comparative advantage is
based on the principle of opportunity
cost. In a one-hour period, a Western
worker can produce either six yards of
cloth or two bushels of wheat. Therefore,
the opportunity cost of cloth is one third
of a bushel of wheat, and the opportunity
cost of wheat is three yards of cloth
An Eastern worker can produce either
one bushel of wheat or one yard of cloth,
so the opportunity cost of wheat is one
yard of cloth, and vice versa.
Cont…
The West has a comparative advantage
in the production of cloth because the
opportunity cost of cloth is one third of a
bushel of wheat, compared to one bushel
of wheat in the East.
Similarly, the East has a comparative
advantage in wheat because the
opportunity cost is one yard of cloth
instead of three.
 Cont…
Comparative advantage may lead to trade between East
and West.
To explain the possible advantages of trade, suppose
that two households, one in the East and one in the
West agree to exchange two yards of cloth for one
bushel of wheat, that is, the price of wheat is two yards
of cloth. If the western household switches one hour of
work from wheat production to cloth production, it
sacrifices two bushels of wheat to produce six additional
yards of cloth.
If it exchanges the extra cloth for three bushels of
wheat from an eastern household, its net gain from
trade is one bushel of wheat.
If the eastern household switches one hour of work from
cloth to wheat production and exchanges the extra
Trade will cause the development of a trading
city if there are scale economies in
transportation.
What about transportation costs?

Trade between the two households is bene­

ficial only if the differences in productivity are
large enough to offset the costs of shipping
wheat and cloth between the two areas.
Trade will be beneficial if transportation
costs are small relative to the differ­ences in
productivity.
If the net gains from trade are positive,
Western households will specialize in cloth
production and eastern households will
Relaxing the Scale Economies in Transportation and Trading Cities
Trade will cause the development of a
trading city if there are scale economies in
transportation.
To explain the importance of scale
economies in transportation, suppose that
there are no scale economies: the transport
cost per bushel of wheat (or yard of cloth)
per mile is independent of the volume
shipped.
 In this case, households in the two regions
engage in direct trade: each eastern
household links up with a western
household to exchange cloth and wheat.
 Cont…
If there are scale economies in transportation,
however, the cost per unit per mile decreases
as the volume transported increases, so it is
cheaper to transport wheat and cloth in bulk.
By exploiting these scale economies, trading
firms can collect, transport, and distribute the
goods at a lower cost than would be incurred
by households engaged in direct trade.
The trading firms locate at places convenient
for the collection and distribution of the
goods, causing the development of
marketplaces at crossroads, ports, river
junctions, and other transshipment points.
 Cont…
The location decisions of traders cause the
development of market cities.
 People employed by the trading firms live near
the marketplace to economize on commuting
costs, and bid up the price of land.
As the price of land increases, residents
economize on land by occupying relatively small
lots. In other words, the population density
around the marketplace is higher than the
population density in the rest of the region.
The combination of comparative advantage and
scale economies & transportation costs causes
 Summary
The market city develops because three
conditions are satisfied:
1. Agricultural productivity is high enough to
produce enough wheat and cloth for themselves
and urban traders.
2. Differences in productivity that generate
comparative advantage are large enough to
offset transportation costs, so trade occurs.
3. There are scale economies in transportation
making large-scale trade and central market
places efficient.
Another
Relaxing the Internalfactor
Scale Economiesin the development of
in Production

cities is Scale Economies in Production.

 One of the assumptions of the model of
rural region is that there are constant
returns to scale in production of wheat
and cloth both.
 If this assumption is dropped factory
production may replace home production
causing the development of industrial
cities.
Scale
Cont… economies arise for two reasons:
1. Factor specialization: In a large operation, each
worker is assigned a single task. The specialization
of labor increases productivity because a worker’s
skills increase with repetition and worker spends
less time switching from task to task.
2. Indivisible inputs: An input to the production
process is indivisible if the input has a minimum
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. A factory uses equipment that
cannot be efficiently scaled down for use by
individual machines. So, as output increases, the
factory uses more indivisible inputs, increasing
 Relaxing the Internal Scale Economies in Production
By locating close to one another, firms can
produce at a lower cost. This is an example of
positive externality in production. The
production cost of a particular firm decreases
as production of other firms increase. There are
two types of agglomerative economies:
localization economies and urbanization
economies.
Localization Economies
Localization economies occur if the production
costs of a firm in a particular industry decrease
as the output of the industry increases.
Cont…
Localization economies occur for three
principal reasons:
1. Scale Economies in intermediate inputs
Some clusters occur because firms in a
particular industry buy an intermediate input
from the same supplier. This happens if two
conditions are fulfilled.
Input demand of an individual firm is not large
enough to exploit scale economies in the
production of intermediate inputs.
Transportation costs are relatively high. If
intermediate input is bulky, fragile or must be
delivered quickly, proximity is important.
Business
Cont… services such as specialized
banking and insurance, transportation
services encourage cluster.
Public services also play a role in the
development of firm clusters. If firms in an
industry require specialized transport
networks or sewage services, public
services costs are lower if firms cluster.
The provision of public education has also
played a role in the development of firm
clusters. Schools, colleges, and universities
provide specialized laborers and engineers
2.
Cont…
Labor Market economies: - cluster increases the
efficiency of the labor market.
In an industry with rapidly changing production
processes and production demand, such as computer
industry, firm’s performances greatly varies.
Workers in the unsuccessful firms move to successful
firms. A cluster facilitates transfer of workers for two
reasons:
First workers in cluster have relatively lower search
costs because information about job openings is spread
through informal channels, and prospective employers
are nearby making formal job searches relatively easy.
Secondly because of physical proximity of employers
moving costs are relatively low. Workers can easily
switch to a different firm. Because search costs and
moving costs are relatively low, firms in cluster can
 Cont…
3. Communication Economies: - cluster
facilitates the rapid exchange of
information and diffusion of technology.
Opportunity to exchange ideas, about new
products and new production techniques
between different firms, their workers,
technicians and managers etc., occurs in
both formal and informal settings.
E.g. a cluster of computer firms produces
a large concentration of computer
scientists and engineers who can
exchange ideas while they work and play.
 Cont…
The incubator process:
 Localization economies are responsible for
incubator process. A cluster of firms, provide a
nurturing environment where firms in an
immature industry "incubate", developing new
products and production process. In the early
life of many industries, demand is unpredictable
and production techniques are unsettled; so
firms cluster to exploit:
1. Exploit scale economies in the production of
intermediate goods
2. Realize labor-market economies, and
3. Exploit the opportunities to ex­change ideas
 Cont…
Urbanization Economies:
Urbanization economies occur if the production
cost of an individual firm decreases as the total
output of the urban area increases.
Urban economies differ from localization
economies in tow ways:
Urbanization economies result from the scale of
the entire urban economy, not of a particularly
industry.
Urbanization economies generate benefits for
all firms throughout the city not firms in
particular industry.
 Cont…
Urbanization economies occur for the same reasons
as localization economies.
Firms from different industries share common input
suppliers, allowing scale economies in the provision
of business services (like banking, insurance, real
estate, hotels, building maintenance, printing
transportation) and public services (highways, mass
transit, schools, fire protection).
Large cities also provide citywide labor market
economies. When a job disappears in one industry
it is likely to be replaced by a new job in another
industry. Search costs and moving costs are lower
in large cities, so firms are able to increase or
decrease their work forces more easily.
Agglomerative Economies in Marketing: Shopping Externalities
This section explains how agglomerative
economies in marketing affect the devel­opment
of cities or how agglomerative economies in
marketing cause trading firms to cluster,
resulting in the development of large market-
based cities.
 A shopping externality occurs if the sales of one
store are affected by the location of other stores.
 Other clusters occur within large cities,
generating downtown shopping areas, malls, and
shopping centers. There are two types of
products that generate shopping externalities:
imperfect substitutes and complements.
Cont…
Imperfect substitutes: Two goods are imperfect
substitutes if they are similar but not identical.
Suppose that you've decided to buy a new mobile
apparatus but haven't decided whether to buy
Nokia, Samsung, or Sony Ericson.
The mobile apparatuses offered by the three
companies are similar, but differ in performance,
shape, color, and extra functions.
Because the differences between the apparatuses
are subtle, you must do your comparison-shopping
in person, spending time and money traveling to
the three apparatuses dealers. If the three dealers
form a cluster, they decrease the cost of
comparison-shopping, attracting consumers to the
 Cont…
Complementary Goods: Clustering also
occurs when firms sell complementary goods.
Complementary goods are often purchased
on the same shopping trip. For example, if a
consumer purchases socks and shoes on the
same trip, his travel cost will be lower if the
socks store is near the shoe store.
The shoe store will benefit from the presence
of the socks store because together they
provide one-stop shopping for consumers.
Because of the benefits of one-stop shopping,
firms selling complementary goods cluster in
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