Chapter 2

Why Do Cities Exist?

1. Innovation and Trading Cities: Numbers

Consider the example shown in Tables 2–1 and 2–2. Suppose a single number changes: The shirt
output per hour in the North is four shirts instead of six shirts. To specialize, a North household
switches one hour from bread to shirts, and a South household switches two hours from shirts to
bread. The exchange rate is three shirts for two loaves. There are scale economies in exchange,
and a transaction takes 30 minutes to execute.

a. The gains from trade are __1 shirt___ for North and __1 shirt ___ for South.
b. A trading city [will/won’t] develop because the opportunity cost of exchange for North is
2 shirts which is greater than the benefit of trade (1 shirt).
c. Suppose an innovation in transportation decreases the transaction time. A trading city will
develop if the transaction time is less than __15___ minutes because the opportunity cost of
exchange is 1 shirt for the North (equal to the gross gain) and 1/4 shirt for South (less
than the gross gain of 1 shirt).

2. Matter Transmitter and Trading City

Consider a region with two standardized products (bread and shirts) that are transported by horse-
drawn wagons. There is a single trading city. Consider the effects of a new matter transmitter, an
indivisible input that is economical for trading fi rms in the city, but not economical for an
individual household. A transmitter instantly transports goods from a production site (a farm or
workshop) to the trading fi rm, and the marginal cost of transport is zero.
a. The labor used in transporting products from production sites to trading fi rms will [increase,
decrease, not change] because the transmitter, with zero production cost replaces the
wagons.
b. The volume of trade in the region will [increase, decrease, not change] because by reducing
the unit transport cost to zero, the transmitter enables full utilization of differences in
comparative advantages that generate comparative advantage and trade.
c. The labor used in processing transactions (banking, accounting, insuring) will [increase,
decrease, not change] because the volume of trade will increase.
d. The trading city will grow if the gains in the labor employed for production and
transaction processing exceeds the losses in terms of labor employed in transportation.
e. Suppose the transmitter technology changes, and it becomes economical for an individual
household. The trading city will [grow, shrink, disappear] because the absence of scale
economies in exchange means that individual households will engage in direct trade.

3. Drilling for Cities

Consider a country with two regions that are separated by a mountain range. Initially each region
is self-sufficient in shirts and bread, and there are no cities. Suppose that a tunnel is drilled
through the mountain, decreasing travel costs between the two regions. The tunnel will cause the
development of a trading city if three following conditions are met. . . .
1. There are differences in productivities that generate comparative advantages.
2. The cost of transportation is small relative to the gross gains from trade.
3. There are scale economies in exchange.

4. Spring-Loaded Sneakers
Consider the example shown in Figure 2–1 , with the “martini-glass” shape showing the net price
of the factory product. Suppose all consumers switch to spring-loaded sneakers, decreasing
walking time per round-trip mile from 1/12 hours to 1/18 hours.

a. The slope of the net-price curve changes to _1/8 loaf_ and the width of the market area
changes from 16 miles (8 on each side) to __24_ miles ( _12_ on each side).
b. Using Figure 2–2 as a starting point, the spring-loaded sneakers change the number of
factories in the 48-mile region from ___3__ to ___2__ , each with a market area __24___
miles wide.
5. Innovation and Market Areas
Consider the example shown in Figure 2–1. Depict graphically the effects of the following
sequence of changes on the “martini glass” figure and the width of a factory’s market area. The
changes are cumulative.
a. An innovation in production that doubles labor productivity in factories will [shorten,
lengthen, not change] the stem of the martini glass from __1/4___ loaves to ___2/12__ loaves
because cost per shirt equals the labor cost per hour (2 loaves) divided by the output per
hour (12 loaves).
b. The width of the market area increases from 16 miles (8 miles on each side) to _20_ miles
( __10_ on each side) because 2/12 + 10/12 = 12/12.
c. An innovation in transportation that doubles consumer travel speeds will [decrease, increase,
not change] the slope of the martini glass from __1/12___ loaf per mile to _1/24__ loaf per
mile.
d. The width of the market area increases from __20__ miles ( _10__ on each side) to _40__
( __20___ on each side) miles because 2/12 + 20/24 = 1.

6. Matter Transmitter in a Factory City

Consider a region with a single factory city that developed as a result of scale economies in
production. Consider the effects of a new matter transmitter, which can instantly transport goods
(but not people) from the factory to any consumer up to 12 miles away, with a zero marginal cost
of transport. The hourly cost of the transmitter is one loaf of bread. Using Figure 2–1 as a starting
point, show the effects of the matter transmitter on the market area of the factory. Is “martini
glass” still an apt descriptor of the figure? If not, what is a better descriptor?
Because transportation has no marginal cost, the slope of the net-price curve is zero, and
instead of a martini glass, we get a goblet with vertical sides 24 miles apart.
7. Singing and the Internet
Consider a region where households produce and consume two products, bread and live musical
performances. All workers are equally productive at producing bread and music. The production
of bread is subject to constant returns to scale, with one hour required to produce each loaf. In an
hour, a single person can produce one unit of music for herself. A choral group of 20 people
working for an hour (on practice and performance) can produce one unit of music for an audience
of 80 people. Assume that the opportunity cost of actually listening to the music is zero. The
travel cost for music consumers is 1/8 hour per round-trip mile.
a. The equilibrium price for choral music—the price paid by each person who listens—is
___1/4__ loaves because 1/4 times 80 listeners cover the opportunity cost of 20 loaves for
the singers.
b. Use a martini-glass figure like Figure 2–1 to show the equilibrium market area of the choral
group. The stem of the martini glass is __1/4___ and the slope is __1/8___ per mile, so the
market area is __6___ on each side because X (1/8) + 1/4=1. X = 6
c. Suppose choral music becomes available on the Internet, and the provider charges 1/2 loaf
per song. Use a martini-glass figure like Figure 2–1 to show the new market area. The market
area is ___2__ miles on each side because. X (1/8) + 1/4= 1/2 X=2

8. Catapult in Retireland
In Retireland, no one commutes to work, and everyone consumes a single good (food), which is
imported from another region and can be purchased (one meal at a time) from the nearest vending
machine. Alternatively, food can be delivered by a distant catapult, capable of flinging a meal
through a food slot on the customer’s roof. The price of a delivered catapult meal is $6 and the
price of a vending-machine meal is $2. The travel cost for consumers is $0.04 per roundtrip meter
($0.02 per meter traveled).
a. Use a martini-glass figure like Figure 2–1 to show the equilibrium market area of the vending
machine. The stem of the martini glass is ___$2__ and the slope is __$0.04___ per meter, and
the horizontal curve showing the cost of catapult meals is at ___$6__ . The market area is
__100___ meters on each side because X (0.04) + 2 = 6. X = 100
b. Arrows up, down, or horizontal: As the distance to the nearest vending machine decreases,
the price of land will increase and population density will decrease.

9. Performance
City Consider a region where households produce and consume musical performances, either live
performances or free recorded performances transmitted over the Internet into homes. After
accounting for price, the utility from a live performance is three times the utility from recorded
music. There are scale economies in the production of live music, which are provided at a
performance center at the center of the region.
a. Using Figure 2–1 as an inspiration, depict graphically a method for determining the market
area of the performance center. Hint: The vertical axis measures utility rather than price.
b. Suppose the demand for live performance is income-elastic, and the demand for recorded
performances is independent of income. Use a second graph to show the effect of an increase
in consumer income on the market area of the performance center.

THIS IS NOT THE REAL ANSWER

10. Diesel Cost and Market Areas

Consider Figure 2–3 , which shows the market areas of sugar-beet processing plants. Suppose
that an increase in the price of diesel fuel doubles the cost of hauling sugar beets from farms to
processing plants. Modify Figure 2–3 to show the effects of higher transport costs.
a. The slope of the net-price curve changes from 0.25$ per mile to __0.50 $__ per mile.
b. If the number of processing plants remains at three, the net price received by the farm that is
most distant from its closest processing plant changes from __$30_ per ton to _$20_ per ton.

11. Beer and Wine

Consider the locations of breweries and wineries.
a. Most breweries locate close to their customers (far from their primary input sources) because
beer production is a weight-gaining activity because breweries add local water (a
ubiquitous input) to other ingredients. Brewing is a market-oriented industry, so it lo-
cates close to its consumers to economize on transport cost.
b. Most wineries locate close to their input sources (far from their consumers) because wine
production is a weight-losing activity (the skins are not used) and the grapes are costly
to transport because of spoilage. Firms in the materials-oriented industry locate close to
input suppliers to economize on transport cost
c. Consider a nation that is 120 miles wide. Beer consumers are uniformly distributed
throughout the nation, while grapes are uniformly distributed through the western region of
the nation. There will be two evenly spaced wineries and two evenly spaced breweries. The
 wineries will locate at mile 15 and mile 45, splitting the western region . The breweries will
locate at mile 30 and mile 90, splitting the nation.

12. Consider a region where the self-sufficient wage is constant at $4. Suppose the payoff from
innovation in a city with population n (measured in thousands) is ( n ) 2
n 12 (n 10 ).
a. Suppose a group of 1 (thousand) workers form a city. Will other workers have an
incentive to join the cluster?
b. Suppose a group of 9 (thousand) workers form a city. Will other workers have an
incentive to join the cluster?
c. Compute the (stable) equilibrium size of the innovation city.