Cost-Benefit Analysis in Monopolistic Competition Models of Urban Agglomeration

Many sources of urban agglomeration involve departures from the first-best world. The benefit evaluation of a transportation project must then take into account agglomeration benefits along with any direct user benefits. Using a monopolistic competition model of differentiated intermediate products, we show that the additional benefits can be expressed as an extended Harberger formula with variety distortion in addition to price distortion. They are positive if variety is procompetitive, but, in the anticompetitive case, we cannot exclude the possibility of negative additional benefits. By introducing the rural sector and multiple cities explicitly, we also show that the agglomeration benefits depend on where the new workers are from.