WHEN DO CITIES SPECIALIZE IN PRODUCTION

When do cities specialize in production and when do they diversify? Wh at determines the size and number of cities in an economy? These quest ions are addressed in a general equilibrium model of a closed economy consisting of a system of circular cities. The economy produces two fi nal manufacturing goods with the use of labor and two groups of non-tr aded differentiated intermediate services. These two manufacturing goo ds are traded within the system at a positive transportation cost. The specialization of cities is due to the desire of the manufacturing in dustries to use a variety of product-specific differentiated intermedi ate services in production. This is because the larger the variety of services in the city the higher is the productivity of the manufacturi ng industries. Diversification is due to higher intercity transportati on costs. The model presented generates two possible equilibrium confi gurations: (i) pure specialization, where each city in the economy spe cializes in the production of one group of differentiated services and one manufacturing good; and (ii) pure diversification, where all citi es in the economy produce both groups of differentiated services and b oth manufacturing goods. The conditions under which each configuration emerges are identified. These conditions depend on the tradeoff betwe en scale economy resulting from specialization and the saving in inter -city transportation costs in the case of diversification. Then some c omparative static results, on stable equilibrium, are presented.