Working Paper No. 13-37 Do Supply Restrictions Raise the Value of Urban Land? the (neglected) Role of Production Externalities

Restriction on the supply of new urban land is commonly thought to raise the value of existing urban land. Our paper questions this view. We develop a tractable production-externalitybased circular city model in which firms and workers choose locations and intensity of land use. Consistent with evidence, the model implies exponentially decaying density and price gradients. For plausible parameter values, an increase in the demand for urban land can lead to a smaller increase in urban rents in cities that cannot expand physically because they are less able to exploit the positive external effect of greater employment density.