Urban Unemployment and City Formation. Theory and Policy Implications

We study the role of unemployment in the context of endogenous formation of a monocentric city where firms set efficiency wages to deter shirking. We first show that in equilibrium the employed locate at the vicinity of the city-center, the unemployed reside at the city-edge and firms set up in the city-center. We then establish conditions that ensure existence and uniquenes of both the labour-market equilibrium and the (monocentric) equilibrium urban configuration. Last, we perform different comparative statics analyses and derive some policy implications. We show in particular that a policy subsidizing the commuter costs of both the employed and unemployed workers reduces urban unemployment, increases utilities of all workers but raises inequality whereas a policy that subsidizes only unemployed workers' commuting costs increases urban unemployment, does not always raise workers' utilities but cuts inequality.