Production Externalities and Urban Configuration

Jacobs (1969) argues that uncompensated knowledge spillovers have played a crucial role in population agglomeration and thus in the generation of cities. We explore this idea formally by extending the Romer (1986) model of (inter-firm) externalities in production to an explicit spatial context. We postulate that knowledge spillovers between firms decrease with the distance between the firms. A general equilibrium model with households and firms residing in a linear or long, narrow city is constructed. The allocation of goods and factors, the locational choice of firm sites and household residences, as well as factor prices and land rents are all endogenously determined. The equilibrium urban configuration may be concentrated (with monocentric firm locations), dispersed (with completely mixed firm and household locations) or a combination (with incompletely mixed firm and household location), depending on the population of firms as the transportation and firm-interaction parameters. Due to the distance-dependent production externalities, firms will be clustered together in any equilibrium. As a consequence, the duo-centric or any multi-centric urban configuration is never an equilibrium configuration. Moreover, except for a set of parameters of measure zero, the equilibrium urban configuration is unique.