A DMP Model of Intercity Trade

The paper presents a model of an economy whose urban structure consists of cities of different types. All cities of different types. All cities produce a non-tradeable final good using both types of tradeable intermediate varieties. Each city has an internal spatial structure: individuals commute to the CBD in order to work, when employed, and to seek jobs, when unemployed. Hiring by each intermediate producing firm is subject to frictions, which are modeled in the Diamond-Mortensen-Pissarides fashion. Job matching requires either travel to the CBD for face to face contacts or, alternatively, referrals from social contacts.City type is conferred by specialization in producing one of the two types of intermediate varieties, diversified cities, where both types are produced, and there is intercity trade in intermediate varieties. The paper examines the properties of equilibrium with intercity trade and its dependence on such parameters as those pertaining to productivity, the matching process, the rate of job destruction and their consequences for unemployment, output and welfare across the economy along a steady state. The model's use of international trade tools confers a central role to labor market tightness, akin to factor intensity. A natural dependence of unemployment on city size is generated. The paper provides a framework for studying spatial mismatch. Equilibrium outcomes generically diverge from the planner's optimum: socially optimal unemployment trades off the probability of employment to search socts of firms independently for each skill type and independently of city size, and city sizes are independent of labor market tightness considerations but reflect both market size effects and the skill composition of the economy.