The logic of spatial equilibrium drives the process of agglomeration

Agglomeration economies are the benefits that accrue from the elimination of distances, or to put it more objectively, from the elimination of transportation cost, whether in the movement of goods, of labour and people, or more importantly, ideas and skills.

The central paradox between agglomeration and the reduction of transportation cost is this: if indeed, costs for transportation have reduced, what new incentives then drive people to come more closely together? For a long time, the general assumption was that people come together to eliminate transportation cost; to eliminate costs that distance imposes on them. But with the development of better communication technology, why has more agglomeration occurred? Indeed, this is one of the foundation questions in contemporary urban economics.

Secondly, urban economists have also spent considerable energy on trying to develop a methodology to capture the process of agglomeration. Urban economists have broadly boiled down to urban wages, real estate prices, and “growth in the number of people within an area”, to capture this process.

To capture the angle of labour, urban economists have relied on the logic of spatial equilibrium. Assuming the costs of mobility is zero; labourers will be indifferent between different cities. The indifference curve is guided by the logic that high wages in one area will be offset by high costs of living or bad amenities; hence theoretically, spatial equality across all cities will be established in wages and costs of living. However, if people all gather in one area because of the fact that high costs of living are complemented by good amenities, then more people tend to gather in that area multiplying the economics of agglomeration. Public finance economists capture this process by looking at property values or real estate prices, where: high housing prices is a function of high wages, high costs of living, and better amenities.

(This post was first published in Takshashila Institution’s blog)

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