Optimal cities

Using a simple model, this paper demonstrates that efficient pricing of factors of production within the city may make a city efficient, yet this does not guarantee that the equilibrium city size will be optimal. Efficiency only means that whatever service level is produced is produced at minimum cost. The failure to take account of the size dimension not only means that a city may be too big or too small, but also means that the service level is non-optimal. The analysis suggests that rather than relying on property taxes to finance municipal expenditures, which tends to make production inefficient, an optimal city should impose a residence tax that equates the benefit of the last resident admitted to the marginal cost of servicing that resident. The central government should be responsible for income redistribution matters as well as revenue transfer between profitable and unprofitable cities.