Specialization and Diversification in a System of Cities

When do cities specialize in production and when do they diversify? When do both specialized cities and diversified cities coexist? What determines the size and number of cities of different types in an economy? These questions are addressed in a general equilibrium model of a closed economy consisting of a system of cities. The economy produces two goods which are traded within the system at no transportation costs. In the context of this model the factor which leads to the formation of specialized cities is internal scale economies due to the existence of fixed cost in production, whereas the reason for the formation of diversified cities is the existence of economies of joint production (i.e., economies of scope). The model presented generates three possible equilibrium configurations: (1) pure specialization, in which each city specialized in the production of one good; (2) pure diversification, in which all cities in the economy produce both goods; (3) mixed system, in which specialized and diversified cities coexist in the economy. The conditions under which each configuration emerges are identified. Thus the model represents an explanation of urban hierarchy in spatial economies.