Essays on Prices and Variety Across Cities
In Krugman (1991), agglomeration is driven by consumption externalities related to differences in the average price across locations. Variety plays a central role here: the price index is lower in larger cities because more varieties are produced there, but all products are available everywhere, so there are no direct consumption gains from variety. Chapter 1 extends this model to allow for these variety differences across cities via an extensive margin of intercity trade. In this model, scale economies yield more production variety in larger cities so that, with positive trade costs, consumers in these locations can benefit from two consumption advantages - lower average prices and more varieties of products. This model sets the stage for the empirical chapters that measure the impact of these consumption benefits on consumer utility. The urban economics literature has paid relatively little attention to these consumption externalities for two reasons. First, the fact that wages are higher in larger cities indicates, in the context of a spatial equilibrium model, that purchasing power must be lower in these locations, which is inconsistent with the NEG theoretical predictions that price indexes are lower in larger cities. Second, there are reasons to believe that intranational trade frictions are much smaller than those across international borders. While there is a large body of work documenting that these frictions yield significant variation in the prices charged and varieties offered across different countries, we know relatively little about the spatial variation of price and variety in a domestic context. Chapter 2, co-authored with David E. Weinstein, addresses both of these issues. We first show that, controlling for purchaser demographics and store amenities, the prices of tradable products do, in fact, vary across cities as predicted by Krugman (1991). Additionally, we find that there are significant differences in the variety of products offered in large as opposed to small cities. We finally measure the extent to which this variation in prices and variety lowers price indexes for tradable products in large cities relative to small cities. This low price index over tradables in large cities is consistent with nominal wages being higher there, as long as there are congestion costs that equalize real income across locations. A major assumption in the work described above is that the consumption benefits of cities do not vary systematically across consumer types. The final chapter of my dissertation considers how systematic differences in prices and variety across space might impact different individuals differently. Previous research has tested whether firms vary prices and product offerings in order to cater local tastes in a market. I extend this analysis to structurally estimate how this behavior of individual firms differentially affects the price indexes faced by consumers with systematically heterogeneous tastes. I allow for tastes to vary with income and find that poor consumers face lower costs in low-income cities, while the opposite holds for wealthy consumers, whose tastes are better-suited to the variety of products available in high-income cities. In conclusion, this dissertation finds that there is significant variation in prices and variety across U.S. cities. In particular, the spatial distributions of prices, variety, and consumers in the U.S. are correlated in a manner consistent with there being consumption externalities. Consumers in larger cities have access to more varieties of products at a lower average price and, conditional on city size, consumers have access to varieties better-suited to the tastes of they share with their income group in cities with per capita incomes closer to their own. These patterns are reflected in the variation in the tradables price indexes that consumers face across large and small and across wealthy and poor cities. This evidence on the existence of the pecuniary consumption externalities hypothesized in early NEG papers supports a growing literature exploring the role of consmption externalities in generating the aggregate and skill-biased agglomeration patterns that the more recent NEG literature associates with production externalities.
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