Chapter 5

Urban Growth
1. Innovation and Growth Numbers
Suppose a region’s workforce of 14 million is initially split equally between two cities, X and Y.
The urban utility curve peaks at 4 million workers, and beyond that point the slope is −$3 per
million workers. The initial equilibrium utility level is $60. Suppose city X experiences
technological innovation that shifts its utility curve upward by $12.
a. Draw a pair of utility curves, one for X and one for Y , and label the positions immediately
after the innovation (before any migration) as x for city X and y for city Y . Use arrows along
the curves to indicate the migration that follows.

The initial utility curve is same for both the cities. The initial point of equilibrium is denoted
as i. Thus, the equilibrium level of utility is $60 and 7 million workers in each city.
After that the city-X experience technological innovation, the utility curve of the city-X shifts
upward. The utility curve shift upward by $12. It means after the technological innovation
(assuming no immigration), the workforce of city-X will enjoy utility level of $72 (point-j).
After the migration, workers form city-Y starts migrating to city-X for the higher utility level
and the process will continue till the gap between the utility is finished. In city-Y, the
migration takes place from point i to point s and in city-X, the change takes place from
point j to b.
Point x: Utility = $72; workforce = 7 million. Point y: Utility = $60; workforce = 7
million. City X moves downward along the negatively sloped part of the utility curve to
a larger population. City Y moves upward along the negatively sloped part of the utility
curve to a smaller population.
b. In the new equilibrium, the utility level is $66 and the population of X is 9 million, while the
population of Y is 5 million.
2. Education Spillover Benefits
Consider a city where the initial wage of high-school dropouts is $10. Suppose the college share
of the workforce increases by 2 percent. Use a demand-supply graph of the labor market for high-
school dropouts to show the effects on the dropout wage. Use the numbers provided in the section
“Human Capital and Economic Growth.”
The increase in the college share increases the demand for high-school dropouts, shifting
the demand curve to the right. The elasticity of the dropout wage with respect to the college
share is 1.9, so the equilibrium dropout wage increases 3.8 percent, from $10.00 to $10.38.

3. Elasticity of Demand for Software Labor

Consider the computer software industry. Assume [i] labor is responsible for 80 percent of
production costs, [ii] software is produced with fixed factor proportions (no capital-labor
substitution), [iii] there are no agglomeration economies, [iv] any change in production cost is
passed on to consumers in a higher price, and [v] the price elasticity of demand for software is
−1.50. Suppose the wage of software workers increases by 20 percent.
a. The price of software will increase by 16 percent, and the quantity of software demanded will
decrease by 24 percent.
Computed as 80% × 20% = 0.8 × 0.8 = 0.16 = 16%
ED= % in quantity demanded/ % in price
-1.50 = % in quantity demanded/ 0.16
% in quantity demanded = -0.24 = 24%
b. The quantity of software labor demanded will decrease by 24 percent.
c. The elasticity of demand for software labor is 1.20, computed as 24%/20% = 1.20
d. If assumption [i] is relaxed, the demand for software labor would be [more, less] elastic
because an increase in the wage would cause substitution of capital for labor.

4. Labor Supply Elasticity: Island City versus Plains City

Island City is located on a small island, while Plains City is located at the center of a large, flat,
featureless plain. Draw two labor-supply curves, one for each city.
a. The supply curve for Island City is [steeper/flatter] because given the limited supply of
land, land and housing prices will increase more rapidly with the size of the
workforce, pulling up wages more rapidly
b. The elasticity of supply of labor in Island City is [higher, lower].

5. Predict Wages and Employment

In the city of Growville, the equilibrium employment is 100,000 workers, and the equilibrium
wage is $100 per day. The elasticity of demand for labor is 1.0 (in absolute value) and the
elasticity of supply of labor is 5.0. The employment multiplier is 2.0. Suppose the demand for
labor used in the production of exports increases by 6,000 jobs.
a. Change in total employment= Change in export employment × Employment multiplier
(6000 × 2 = 12,000) the demand curve shift to the right by 12,000 jobs

b. The equilibrium wage increases by 2 percent (to $102) computed as 12% / (1 + 5) = 2%

Percentage change in equilibrium wage= Percentage change in Demand/ Ed + Es
c. The equilibrium employment increases by 10 percent (to 110,000) computed as
2% x 5= 10%
Percentage change in quantity of labor= Es × % change in Wage

6. Katrina Decreases Labor Supply

Consider the effects of a natural disaster like hurricane Katrina on a metropolitan economy. In the
initial (prehurricane) equilibrium, total employment in the metropolitan area is 500,000 workers
and the daily wage is $100. The price elasticity of supply of labor is 4.0 and the price elasticity of
demand for labor is −1.0. Suppose the hurricane reduces labor supply (a horizontal shift of the
supply curve) by 100,000 workers.
a.

b. The equilibrium wage increases by 4 percent (to $104) computed as 20% / (1 + 4) = 4%

Percentage change in equilibrium wage= Percentage change in Demand/ Ed + Es
c. The equilibrium employment decreases by 4 percent (to 480.000) computed as
4% × 1 = 4 %
Percentage change in quantity of labor= Ed × % change in Wage
d. The reduction in the equilibrium employment is less than the initial decrease in labor supply
because wage increases increase the amount of labor supplied

7. Growth Control and Wages

Consider a city with an equilibrium wage of $80 per day, equilibrium employment of 100,000
jobs, and 100 million square feet of housing. The government’s growth-control policy fixes the
maximum total square footage in the city at its current level. New housing can be built, but every
square foot of new housing requires that one square foot of old housing be retired from the
market.
a. Draw a graph with two labor-supply curves, a conventional supply curve and a second that
represents labor supply under the city’s growth-control policy.
b. The supply curve under the growth-control policy is [steeper, flatter] because an increase in
the workforce causes housing prices to rise and the wage needed to recruit workers to
rise more rapidly.
c. Add two labor-demand curves to your graph, an initial demand curve, and a second curve
representing a 20 percent increase in labor demand.

d. The increase in the demand for labor [increases, decreases, does not affect] the equilibrium
wage. The wage change is [larger, smaller] under the growth-control policy because of a
steeper supply curve.
e. Under the growth-control policy, an increase in the demand for labor [increases, decreases,
does not affect] equilibrium employment. The housing consumption per worker [increases,
decreases, doesn’t change] because housing prices are higher.

8. Effects of Environmental Policy

Consider a city that imposes a new pollution tax that increases the average cost (and price) of the
good produced by a polluting industry by 4 percent and improves the city’s environmental quality
by 20 percent. The price elasticity of demand for the city’s export goods is -1.50.
a. The total output of the polluting industry will decrease by 6% percent, computed as 4% ×
1.50 = 6 %
b. The city’s equilibrium wage will [increase, decrease] because labor demand decreases and
labor supply increases.
c. The city’s equilibrium employment will increase if the elasticity of the supply of labor with
respect to environmental quality is relatively [large, small].
d. Use a supply-demand graph of the urban labor market to illustrate your answer to ( c ).

See Figure 5-5 for a case in which the

supply shift is large relative to the demand
shift.
9. Inefficient Environmental Policy
Consider a city where each polluting fi rm initially generates two tons of pollution. Half the
polluters (type L) could cut back pollution at a cost of $4 per ton, and the other half (type H)
could cut back at a cost of $30 per ton. The city is considering two alternative environmental
policies:
i. Pollution tax: Each fi rm would pay a tax of $5 for each unit of pollution.
ii. Uniform-reduction: Each firm would be required to cut its pollution in half, to one
ton.
a. The tax policy is [more, less] efficient than the uniform-reduction policy because firm (H)
does all the abatement at a cost $4+$4 = $8 rather than splitting the abatement between
the two firms at a cost = $30+$4=$34
b. The pollution tax causes a [smaller, larger] shift of the city’s labor-demand curve because it
increases population costs by a smaller amount.
c. The city is more likely to experience an increase in total employment under the policy
because it decreases labor demand by a smaller amount.
d. Illustrate with two graphs, one for each policy.
The tax policy has a smaller leftward shift of the labor demand curve, and thus a larger
quantity of labor.

10. Economic Impact of a Football Team

Consider the results of a consultant’s report on the possible economic impacts of moving the
Raiders (a professional football team) to Sacramento. The consultant estimated that the team
would increase total spending in the Sacramento economy by $61.6 million per year, computed as
follows:
Increase in spending = Spending per fan × Attendance × Average multiplier
$61.6 million = $40 × 700,000 × 2.20
a. The use of the city’s average multiplier is based on two troublesome assumptions. List the
assumptions and explain why they are troublesome.
Assumption 1: Spending on football games is equivalent to spending on an export good
such as computer chips or steel. This is troublesome because we expect a large fraction
of spending on football to come at the expense of local goods such popcorn in theaters, t-
shirts in clothing stores, movie admission, and restaurant meals.
Assumption 2: Football players and other football workers spend their money like other
workers, with a large fraction spent locally. This is troublesome because many players
are likely to live outside the Sacramento area. For example, many may stay in Los
Angeles and generate multiplier effects there rather than in Sacramento.
b. According to Ms. Wizard, “If my assumptions are correct, total spending in the Sacramento
economy would actually decrease.” Assume that her logic is correct. List her two
assumptions.
Assumption 1A: All the fans come from the Sacramento area, so there is no export
component to the football operation. Assumption 2A: At least some of the players live
outside Sacramento and spend their income elsewhere.