Second-Best Cost-Benefit Analysis in Monopolistic Competition Models of Urban Agglomeration

Many sources of urban agglomeration involve departures from the first-best world. By modeling the microstructure of agglomeration economies, we derive second-best benefit evaluation formulae for urban transportation improvements. Previous work has investigated the same problem, but without explicitly modeling the sources of agglomeration economies. Accordingly, our analysis examines whether earlier results remain valid when monopolistic competition with differentiated products provides the microfoundation of the agglomeration economies. By explicitly introducing the rural sector and multiple cities, we also show that the agglomeration benefits depend on where the new workers are from.