June 2017
Abstract
We introduce location choice in a multi-sector general equilibrium model to study how it affects development accounting. Producers in agriculture, manufacturing and services choose their location to trade off land rents with transport costs to the city center. We show how space affects the aggregate production function and decompose output per worker into productivity, land per worker, and a term adjusting for sector location. In our model, services are luxury goods. As a result, richer cities have larger service cores, higher service prices, and relatively less output per worker in services. These predictions are broadly consistent with the data. We calibrate our model to data on cities in OECD countries and show that land and location explain 10--30 percentage points of the variation in output per worker.