A DMP model of intercity trade

Abstract

Job matching, a central feature of DMP theory, requires contacts between prospective employers and employees. This paper assumes that they may be either face-to-face and take place at city centers or via referrals from social contacts. The paper presents a model of an economy whose urban structure consists of cities of different types. All cities produce a non-tradeable final good using ranges of tradeable intermediate varieties. Each city has an internal spatial structure: individuals commute to the CBD in order to work, when employed, and to seek jobs, when unemployed. Hiring by each intermediate producing firm is subject to frictions, which are modeled in the Diamond–Mortensen–Pissarides fashion. City type is conferred by specialization in producing one of two types of intermediate varieties and there is intercity trade in intermediate varieties. The paper examines properties of equilibrium with intercity trade and its dependence on various parameters and their consequences for unemployment, output and welfare across the economy along a steady state. The model's use of international trade tools confers a central role to labor market tightness, akin to factor intensity. A natural dependence of unemployment on city size is generated. Equilibrium outcomes generically diverge from the planner's optimum: there exists mismatch generically. Socially optimal unemployment trades off the probability of employment to search costs of firms independently for each skill type and independently of city size. Socially optimal city sizes are independent of the matching model and therefore labor market tightness considerations but reflect both market size effects and the skill composition of the economy.