Discussion Paper Series in Economics,
Norwegian School of Economics, Department of Economics

Abstract: This paper develops a model for analysing problems related to centralisation and decentralisation. The model is of the new economic geography type, in which there are agglomeration gains in cities but not in rural areas. These gains are counteracted by residential preferences. We show that, even though people have preferences for rural living, an unregulated market economy gives too little centralisation. This result holds even when city governments actively pursue policies to attract economic activities in order to make their city bigger. When allowing for cities of unequal size, a likely outcome is that big cities and rural areas will be overpopulated whereas smaller cities will be too few and too small.

Keywords: Number of cities; size of cities; external economies; local public inputs; regional competition; agglomeration; welfare.

JEL-codes: H32; H41; R12; R13; R50

49 pages, August 17, 2010

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