Arthur O’Sullivan Urban Economics

Over the course of two decades, Urban Economics has achieved a worldwide
audience, and has been translated into Chinese, Greek, Russian, and Korean. Like the
seven previous editions, this edition provides a clear and concise presentation of the
economic forces that:
cause the development of cities;
determine the spatial form of cities;
cause urban economies to grow or shrink;
generate urban problems such as poverty, crime, and congestion;
make the market for urban housing unique; and
shape the tax and spending policies of local government.

In addition to developing the basic concepts of urban economics, the book uses
economic analysis to evaluate the merits of policies designed to address our most
vexing urban problems.

nEW and HaLLmarK FEaTUrEs
•
•
•

•

For more information and resources visit the text’s website at www.mhhe.com/osullivan8e

Urban Economics
Arthur O’Sullivan

MD DALIM #1162482 09/01/11 CYAN MAG YEL BLK

•
•

O’Sullivan

•

A new chapter on urban education explores the contributions of the key inputs to the
production process, including the home environment, peer groups, and teachers.
A thoroughly revised chapter 11 on urban transit incorporates the most recent
developments in theory, empirical results, and practice.
New material in chapter 2 explores the connections between education, innovation,
and urban development.
Chapter 1 introduces the axioms of urban economics, which provide a foundation
for economic analysis throughout the book.
GIS-generated maps allow the visualization of the key features of the urban economy.
End-of-Chapter Exercises give students the opportunity to test their mastery of the
material and extend the analysis.
A user-friendly Microeconomics Appendix gives students the opportunity to review
relevant economic concepts in a just-in-time fashion.

8th edition

Urban Economics

•
•
•
•
•
•

8th edition

DiscoVEr WHaT maKEs o’sULLiVan’s URBAN ECONOMICS so PoPULar


Urban Economics
EIGHTH EDITION

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Urban Economics
EIGHTH EDITION

Arthur O’Sullivan
Department of Economics
Lewis & Clark College

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URBAN ECONOMICS, EIGHTH EDITION
Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York,
NY, 10020. Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Previous editions © 2009, 2007, and 2003.
Printed in the United States of America. No part of this publication may be reproduced or distributed in any form or by any means,
or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill Companies, Inc., including, but
not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning.
Some ancillaries, including electronic and print components, may not be available to customers outside the United States.
This book is printed on acid-free paper.
1 2 3 4 5 6 7 8 9 0 QFR/QFR 1 0 9 8 7 6 5 4 3 2 1
ISBN 978-0-07-351147-4
MHID 0-07-351147-1
Publisher: Douglas Reiner
Sponsoring Editor: Daryl Bruflodt
Director of Marketing & Sales: Jennifer J. Lewis
Project Manager: Melissa M. Leick
Buyer: Susan K. Culbertson
Design Coordinator: Margarite Reynolds
Media Project Manager: Balaji Sundararaman
Cover Designer: Mary-Presley Adams
Cover Image Credit: Imagezoo/Getty Images
Typeface: 10/12 Times Roman
Compositor: MPS Limited, a Macmillan Company
Printer: Quad/Graphics
Library of Congress Cataloging-in-Publication Data
O’Sullivan, Arthur.
Urban economics / Arthur O’Sullivan. — 8th ed.
p. cm.
Includes index.
ISBN 978-0-07-351147-4
1. Urban economics. I. Title.

HT321.O88 2012
330.9173'2—dc23
2011022545

www.mhhe.com

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To Professor Ed Whitelaw, the most talented teacher I’ve ever known.
It has been almost 30 years since I’ve been in Ed’s class, but whenever
I start thinking about how to teach some new material,
my first thought is “How would Ed present this material?”

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About the Author

ARTHUR O’SULLIVAN is a professor of economics at Lewis and Clark College
in Portland, Oregon. After receiving his B.S. degree in economics at the University

of Oregon, he spent two years in the Peace Corps, working with city planners in the
Philippines. He received his Ph.D. degree in economics from Princeton University
in 1981 and taught at the University of California, Davis and Oregon State University, winning teaching awards at both schools. He is the Robert B. Pamplin Junior
Professor of Economics at Lewis and Clark College in Portland, Oregon, where he
teaches microeconomics and urban economics. He is the coauthor of the introductory textbook, Economics: Principles and Tools, currently in its seventh edition.
Professor O’Sullivan’s research explores economic issues concerning urban
land use, environmental protection, and public policy. His articles appear in many
economics journals, including Journal of Urban Economics, Regional Science and
Urban Economics, Journal of Environmental Economics and Management, National
Tax Journal, Journal of Public Economics, and Journal of Law and Economics.

vii

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Preface
This book is on urban economics, the discipline that lies at the intersection of
geography and economics. Urban economics explores the location decisions of utility-maximizing households and profit-maximizing firms, and it shows how these
decisions cause the formation of cities of different size and shape. Part I of the book
explains why cities exist and what causes them to grow or shrink. Part II examines
the market forces that shape cities and the role of government in determining landuse patterns. Part III looks at the urban transportation system, exploring the pricing
and design of public transit systems and the externalities associated with automobile use (congestion, environmental damage, collisions). Part IV explores the economics of urban education and crime, two factors that play key roles in household

location decisions. Part V explains the unique features of the housing market and
examines the effects of government housing policies. The final part of the book
explains the rationale for our fragmented system of local government and explores
the responses of local governments to intergovernmental grants and the responses
of taxpayers to local taxes.
The text is designed for use in undergraduate courses in urban economics and
urban affairs. It could also be used for graduate courses in urban planning, public
policy, and public administration. All of the economic concepts used in the book
are covered in the typical intermediate microeconomics course, so students who
have completed such a course will be able to move through the book at a rapid
pace. For students whose exposure to microeconomics is limited to an introductory
course— or who could benefit from a review of the concepts covered in an intermediate microeconomics course—I have provided an appendix (“Tools of Microeconomics”) that covers the key concepts.

CHANGES FOR THE EIGHTH EDITION
The eighth edition improves on the previous edition in two ways. First, I’ve
rewritten Chapter 11 (Urban Transit) to incorporate the most recent developments
in economic theory, empirical results, and practical experience with transit systems. Included in the revised chapter is a thorough analysis of the rationale for transit subsidies and a discussion of the size of the socially efficient subsidy. In addition, the chapter has a full accounting of the relative costs of light rail versus buses.

ix

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x

Preface

The second improvement is a new chapter on education (Chapter 12). This

chapter uses the education production function as a framework to explore the economics of K–12 education. The chapter identifies the key inputs to the production process—teachers, the home environment, and classroom peers. One of the
insights from the production function is that teacher productivity varies significantly across teachers. For example, if we replace an average teacher with an aboveaverage teacher for one year, the benefit is roughly $210,000. At the other end of
the productivity scale, if we were to replace the bottom 8 percent of teachers with
average teachers, aggregate earnings in the national economy would increase by
roughly $112 trillion. The education chapter also looks at spending inequalities
across schools and evaluates the effects of intergovernmental grants on spending
and achievement inequalities.

WEB SITE
The Web site for the book (www.mhhe.com/osullivan8e) has the following resources.
• Color versions of the maps in the book
• Maps for other cities
• For each chapter
• PowerPoint presentations, which include all the figures and tables from the
text
• Lecture notes
• A chapter, “The Core-Periphery Model of Regional Development,” that presents
some key ideas from economic geography
• A list of corrections. The author has a typo-bounty program that pays $5 to the
first person to identify a particular error.
The instructors’ version of the Web site also has model answers to the exercises in
the book.

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Acknowledgments

I am indebted to many people who read the book and suggested ways to improve
the coverage and the exposition. In particular I would like to thank those instructors
who participated in surveys and reviews that were indispensable in the development
of the Eighth Edition of Urban Economics. The appearance of their names does not
necessarily constitute their endorsement of the text or its methodology.
Oliver D. Cooke

Steven R. Nivin

Richard Stockton College of New Jersey

St. Mary’s University

Jonathan Diskin

Joseph Michael Pogodzinski

Earlham College

San Jose State University

Kristie A. Feder

Jeffrey Pompe

Bard College

Francis Marion University

Gary Frimann

Margaret A Ray

Gavilan College

University of Mary Washington

Anthony Joseph Greco

Jesse J. Richardson, Jr

University of Louisiana-Lafayette

Virginia Tech

Peter E. Howe

Paul Rivera

Cazenovia College

Wheaton College

Haydar Kurban

Frederica Shockley

Howard University

California State University, Chico

Thomas J. Muench

John D. Wong

State University of New York Stony Brook

Wichita State University

xi

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xii

Acknowledgments

In addition, dozens of instructors provided feedback and suggestions for earlier
editions of the book.
Richard Arnott

Steven Durlauf

Boston College

University of Wisconsin

Randall Bartlett

Ingrid Gould Ellen

Smith College

Wagner School, New York University

Charles Becker

Erwin F. Erhardt, III

Department of Economics, Duke University

University of Cincinnati

Charles Berry

David Figlio

University of Cincinnati

University of Oregon

Bradley Braun

Edward J. Ford

University of Central Florida

University of South Florida

Jerry Carlino

Tom Fullerton

University of Pennsylvania

Paul Carrillo
George Washington University

Suparna Chakraborty
Dept. of Economics and Finance,
Zicklin School of Business,
Baruch College, CUNY

Brian J. Cushing
West Virginia University

Maria N. DaCosta
University of Wisconsin–Eau Claire

Joseph Daniel

University of Texas at El Paso

Andrew Gold
Trinity College

Alan Day Haight

SUNY–Cortland

Bríd Gleeson Hanna
Rochester Institute of Technology

Julia L. Hansen
Western Washington University

Daryl Hellman
Northeastern University

University of Delaware

Barry Hersh
Eastern Illinois University

Steven L. Newman Real Estate Institute,
Baruch College, City University of New York

Gilles Duranton

Diane Hite

University of Toronto

Auburn University

Minh Quang Dao

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xiii

Acknowledgments

Bruce K. Johnson

Michael J. Potepan

Centre College

San Francisco State University

Christopher K. Johnson

David A. Quart

University of North Florida

NYU–Wagner Graduate School of Public
Service

Stanley Keil
Ball State University

Steven Raphael
University of California, San Diego

Sukoo Kim
Washington University

Donald Renner
Minnesota State University

MaryJane Lenon, Ph.D.
Providence College, Providence, RI

Jesse J. Richardson, Jr.
Virginia Tech

James P. LeSage
Texas State University–San Marcos

Craig Rogers
Canisius College

Kenneth Lipner
Florida International University

Jonathan Rork
Vassar College

Roxanne Ezzet-Lofstrom
University of Texas at Dallas

Stuart S. Rosenthal
Syracuse University

Vijay Mathur
Cleveland State University

Jeffrey Rous
University of North Texas

Dr. Warren McHone
University of Central Florida

William A. Schaffer
Georgia Institute of Technology

Kevin J. Murphy
Oakland University

Steve Soderlind
Saint Olaf College

James K. O’Toole
California State University, Chico

Dean Stansel
Florida Gulf Coast University

Bruce Pietrykowski
University of Michigan–Dearborn

Mary Stevenson
University of Massachusetts, Boston

Florenz Plassmann
Binghamton University, State University
of New York

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Will Strange
University of Toronto

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xiv

Acknowledgments

Edward F. Stuart

Mark R. Wolfe

Northeastern Illinois University

University of California, Berkeley

Timothy Sullivan

Anthony Yezer

Towson University

George Washington University

Jacques-Francois Thisse

King Yik

Universite Catholique de Louvain-la-Neuve

Idaho State University

Wendine Thompson-Dawson

John Yinger

University of Utah

Syracuse University

Arthur O’Sullivan

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Brief Contents

Preface

ix

Acknowledgments

Chapter 1

xi

Introduction and Axioms of Urban Economics

1

Part I
MARKET FORCES IN THE DEVELOPMENT OF CITIES

15

Chapter 2

Why Do Cities Exist?

17

Chapter 3

Why Do Firms Cluster?

45

Chapter 4

City Size

70

Chapter 5

Urban Growth

92

Part II
LAND RENT AND LAND-USE PATTERNS

125

Chapter 6

Urban Land Rent

127

Chapter 7

Land-Use Patterns

161

Chapter 8

Neighborhood Choice

202

Chapter 9

Zoning and Growth Controls

230

xv

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xvi

Brief Contents

Part III
URBAN TRANSPORTATION
Chapter 10

Autos and Highways

257

Chapter 11

Urban Transit

290

Part IV
EDUCATION AND CRIME IN CITIES

315

Chapter 12

Education

317

Chapter 13

Crime

338
Part V
HOUSING

Chapter 14

Why Is Housing Different?

Chapter 15 Housing Policy
Part VI

LOCAL GOVERNMENT

365
367
386

409

Chapter 16

The Role of Local Government

411

Chapter 17

Local Government Revenue

431

Appendix Tools of Microeconomics
Index

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255

455

479

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Contents

Preface

ix

Acknowledgments

Chapter 1

xi

Introduction and Axioms of Urban Economics

What Is Urban Economics?
What Is a City?

1

2

Why Do Cities Exist?

3

The Five Axioms of Urban Economics

1.
2.
3.
4.
5.

7

Prices Adjust to Achieve Locational Equilibrium
7
Self-Reinforcing Effects Generate Extreme Outcomes
Externalities Cause Inefficiency
9
Production Is Subject to Economies of Scale
10
Competition Generates Zero Economic Profit
11

What’s Next?

Census Definitions

Urban Population

12

12

12

Metropolitan and Micropolitan Statistical Areas
Principal City

9

11

References and Additional Reading

Appendix

1

13

14

xvii

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xviii

Contents

PART I
MARKET FORCES IN THE DEVELOPMENT OF CITIES

Chapter 2

Why Do Cities Exist?

17

A Region without Cities—Backyard Production
A Trading City

15

17

18

Comparative Advantage and Trade
19
Scale Economies in Exchange
19

Trading Cities in Urban History

20

Trading Cities in World History
20
Trading Cities in American History
21

A Factory City

22

Determining Wages and Prices
22
The Market Area of a Factory City
23

The Industrial Revolution and Factory Cities
Innovations in Manufacturing
25
Innovations in Transportation
26
Innovations in Agriculture
26
Energy Technology and Location Decisions

A System of Factory Cities

24

26

27

Resources-Oriented Firms and Processing Cities
Scale Economies and Market Areas
29
System of Processing Cities
30

Other Examples of Resources-Oriented Industries

Innovation Cities
Summary

33
34

References and Additional Reading

37

Location Decisions of Transfer-Oriented Firms

Resource-Oriented Firms
Market-Oriented Firms

38

39
40

The Principle of Median Location
Transshipment Points and Port Cities

osu11471_fm_i-xxx.indd xviii

30

31

Applying the Concepts

Appendix

29

42
43

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xix

Contents

Chapter 3

Why Do Firms Cluster?

Sharing Intermediate Inputs

45

47

Dresses and Buttons
48
High-Technology Firms

49
Intermediate Inputs in the Movie Industry

49

Self-Reinforcing Effects Cause Industry Clusters
The Benefits and Costs of Clustering
50
The Profit Gap and the Size of the Cluster

Sharing a Labor Pool

52

52

The Isolated Firm
53
Locating in a Cluster
54
Expected Profits Are Higher in the Cluster
Labor Pooling in the Movie Industry
55

Labor Matching

50

54

55

A Model of Labor Matching
56
Agglomeration Economies: More Workers Implies Better Matches

Knowledge Spillovers

57

58

Evidence of Localization Economies
Urbanization Economies

59

60

Sharing, Pooling, and Matching
60
Corporate Headquarters and Functional Specialization
Knowledge Spillovers
61
Evidence of Urbanization Economies
62

Other Benefits of Urban Size

60

62

Joint Labor Supply
63
Learning Opportunities
63
Social Opportunities
64

Summary

64

Applying the Concepts

64

References and Additional Reading

Chapter 4

67

City Size

Utility and City Size

70
70

Benefits and Costs of Bigger Cities
70
Locational Equilibrium, Land Rent, and Utility within a City

A System of Cities

73

Cities Are Not Too Small
Cities May Be Too Large

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72

73
75

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xx

Contents

Specialized and Diverse Cities

76

A Model of Laboratory Cities
76
Example: The Radio Industry in New York
Evidence of Laboratory Cities
77

Differences in City Size

77

78

Differences in Localization and Urbanization Economies
Local Goods and City Size
79
Local Employment Amplifies Size Differences
79

The Size Distribution of Cities

80

The Rank-Size Rule
81
Urban Giants: The Puzzle of Large Primary Cities

Summary

78

82

83

Applying the Concepts

84

References and Additional Reading

87

Appendix Central Place Theory
References

Chapter 5

88

91

Urban Growth

92

Economic Growth: Increase in Per-Capita Income
City-Specific Innovation and Income
Regionwide Innovation and Income

93

95

Human Capital and Economic Growth
The Urban Labor Market

92

95

96

Urban Labor Demand
96
Shifting the Urban Labor Demand Curve
98
Export versus Local Employment and the Multiplier
99
The Labor-Supply Curve
101
Equilibrium Effects of Changes in Supply and Demand
102

Employment Growth and Decline of the U.S. Manufacturing Belt
The Role of Human Capital
105
Labor and Housing Markets in Shrinking Cities

105

106

Public Policy and Equilibrium Employment

107

Taxes and Firm Location Choices
107
Public Services and Location Decisions
108
Subsidies and Incentive Programs
108
Professional Sports, Stadiums, and Jobs
109
Environmental Quality and Employment
110

Projecting Changes in Total Employment

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111

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xxi

Contents

Who Benefits from Increased Employment?

Who Gets the New Jobs?
112
Effects on Real Income per Capita

Summary

112

114

Applying the Concepts

114

References and Additional Reading

Appendix

112

117

The Regional Context of Urban Growth

The Neoclassical Model

118

119

Differences in Natural Advantage Cause Concentration
119
A Decrease in Transport Costs Causes Regional Dispersion
120

Regional Concentration and Dispersion in the United States
References and Additional Reading

121

123

PART II
LAND RENT AND LAND-USE PATTERNS
Chapter 6

125

Urban Land Rent

Introduction to Land Rent

127
127

Bid-Rent Curves for the Manufacturing Sector

128

The Negatively Sloped Rent Curve

129
Rent on Industrial Space in Los Angeles
130

Bid-Rent Curves for the Information Sector
Travel for Information Exchange
131
Office Bid-Rent Curve with a Fixed Lot Size

130
132

Office Bid-Rent Curves with Factor Substitution

134

Building Options: The Office Isoquant
134
Factor Substitution: Choosing a Building Height
135
Factor Substitution Generates a Convex Bid-Rent Curve
Rent on Office Space: Los Angeles and Atlanta
138

Housing Prices

136

139

Linear Housing-Price Curve: No Consumer Substitution
139
Consumer Substitution Generates a Convex Housing-Price Curve
Apartment Rents in Portland, Oregon
143

The Residential Bid-Rent Curve

141

143

Fixed Factor Proportions
143
Factor Substitution
144
Residential Density
145

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xxii

Contents

Relaxing the Assumptions: Time Costs, Public Services, Taxes, Amenities
Land-Use Patterns

146

Bid-Rent Curves for Business
Territories of Different Sectors

147
149

Henry George and the Single Tax on Land
Summary

150

151

Applying the Concepts

152

References and Additional Reading

155

Appendix Consumer and Factor Substitution
Consumer Choice and the Law of Demand
Maximizing Utility: MRS ϭ Price Ratio
Consumer Substitution
157
Locational Equilibrium

158

156
156

157

Input Choice and Factor Substitution

Chapter 7

145

159

Land-Use Patterns

161

The Spatial Distribution of Employment

161

Jobs Inside and Outside the Central Area
161
A Closer Look at the Spatial Distribution of Jobs: Portland and Boston
163
Employment Subcenters: Los Angeles and Chicago
164
The Spatial Distribution of Office Employment and Office Space

166
Edge Cities
166
The Role of Subcenters in the Metropolitan Economy
168

The Spatial Distribution of Population

169

Population Density in Portland and Boston
Density in World Cities
171
Commuting Patterns
172

The Rise of the Monocentric City

169

174

Innovations in Intracity Transportation
174
The Technology of Building Construction
175
The Primitive Technology of Freight
176

The Demise of the Monocentric City

176

Decentralization of Manufacturing: Trucks and Highways
176
Other Factors: Automobile, Single-Story Plants, and Airports
178
Decentralization of Office Employment
178
Decentralization of Population
180

Urban Sprawl

181

Sprawl Facts
181
The Causes of Sprawl
183
European Policies
184

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xxiii

Contents

The Consequences of Sprawl
Policy Responses to Sprawl?

Are Skyscrapers Too Tall?
Summary

184
186

186

188

Applying the Concepts

189

References and Additional Reading

Appendix

191

The Monocentric Model and Applications

193

The Monocentric Model

193
Income and Location
195
Trade-off between Commuting and Housing Costs
Other Explanations
197

195

A General Equilibrium Model of a Monocentric City
Interactions between the Land and Labor Markets
The General Equilibrium Effects of the Streetcar

Applying the Concepts

Chapter 8

198

198
198

201

Neighborhood Choice

Diversity versus Segregation

202
202

Sorting for Local Public Goods

203

Diversity in Demand for Local Public Goods
204
Problems with Majority Rule and Formation of Municipalities
Variation in Consumption of the Taxed Good
206

Neighborhood Externalities
Neighborhood Choice

205

207

208

Segregation Equilibrium
210
Integration as a Stable Equilibrium
211
Mixed Neighborhoods
212
Lot Size and Public Policy
213
Minimum Lot Size Zoning and Segregation

214

Neighborhood Choices: The Roles of Education and Crime

215

Education and Neighborhood Choice
215
Crime and Neighborhood Choice
216

Racial Segregation

218

Racial Preferences and Neighborhood Choice
Other Reasons for Racial Segregation
221

The Consequences of Segregation

222

Unfavorable Neighborhood Effects
222
Limited Access to Jobs: The Spatial Mismatch
Moving to Opportunity
224

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219

223

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xxiv

Contents

Summary

225

Applying the Concepts

225

References and Additional Reading

Chapter 9

228

Zoning and Growth Controls

Land-Use Zoning

230

230

The Early History of Zoning
231
Zoning as Environmental Policy?
231
Fiscal Zoning
232
Minimum Lot Zoning and the Space Externality
Provision of Open Space
234

The Legal Environment of Zoning

233

235

Substantive Due Process
236
Equal Protection
237
Just Compensation
237

A City without Zoning?

238

Growth Control: Urban Growth Boundaries

239

Precise Growth Control: Limiting Land Area and Lot Size
240
Winners and Losers from Growth Boundaries
241
Urban Growth Boundary and Density
242
Portland’s Urban Growth Boundary
244
Municipal versus Metropolitan Growth Boundaries
244
Trade-offs with Growth Boundaries and Open Space
244

Other Growth-Control Policies
Limiting Building Permits
Development Taxes
247

245

245

Housing Regulations and Housing Prices
Summary

247

249

Applying the Concepts

250

References and Additional Reading

253

PART III
URBAN TRANSPORTATION
Chapter 10

Autos and Highways

Congestion Externalities

257

260

The Demand for Urban Travel
261
The Private and Social Costs of Travel
262
Equilibrium versus Optimum Traffic Volume

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255

263

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