Economies of scope in intermediate goods and a system of cities

Abstract

The objective of this paper is to present a microfoundation model of industrial agglomeration and city formation. This is accomplished by extending Abdel-Rahman and Fujita ( Journal of Urban Economics, 1993, 33, 189–222) in two respects. First, a market for intermediate goods/services is introduced which leads to the formation of a multifirm city. Secondly, the impacts of economies of scope, resulting from lower variable costs as well as fixed costs, in intermediate goods are examined. A spatial general equilibrium model of a system of cities in a closed economy is employed. In this economy, two final traded goods are produced with the use of labor and non-traded intermediate goods. The model generates different equilibrium parameter spaces depending on the form of economies of scope, i.e. whether and to what degree economies of scope affect fixed or variable costs. Therefore, economies of scope in intermediate goods production have different effects than do economies of scope in final goods production. In addition, it is shown that under some conditions, in a stable equilibrium, the specialized city can be larger than the diversified city.