URBAN SYSTEMS:MARKET AND EFFICIENCY DAVID PINES Tel Aviv University JACQUES FRANÇOIS THISSE Université Catholique de Louvain 1. What Is the Urban Question About? The most salient feature of the spatial economy is the extreme variation in land use intensity, which culminates in the emergence of cities. The com- mon research strategy in the economic modeling of human settlements is to assume that some activities are characterized by scale economies and others by scale diseconomies, the economic landscape being the balanc- ing point between these two forces. According to Tiebout, Stiglitz, and others, the main source of scale economies is the sharing cost of collective goods. According to Mirrless, Henderson, and others, the source of scale economies lies in the production of private goods, scale economies being either internal or external to firms. Whatever their origin, it seems to be problematic to consider the economic landscape as an equilibrium out- come since scale economies are hardly consistent with perfect competi- tion. One way out is to assume that a single agent, referred to as a developer ~which may be a local government! , is responsible for both the activities involving scale economies and those involving diseconomies, using cross subsidization to break even. In particular, developers may subsidize scale economies in production or public goods by using land rent earned from housing supply. Within such a framework, how does the market balance the various forces at work? More precisely, ~a! does the market succeed or fail in inducing the efficient distribution of population across cities? and ~b! if it fails, is the city distribution skewed toward excessive or insufficient agglomeration? In designing urban policy, it is often presumed that the answer to the first question is negative, while it is also believed that cities are too big, David Pines, the Eitan Berglas School of Economics, Ramat Aviv, Tel Aviv University, Israel 69778 ~pines@post.tau.ac.il! . Jacques-François Thisse, CORE, Université Catholique de Lou- vain, 34 Voie de Roman Pays, 1348 Louvain-la-Neuve, Belgium ~Thisse@core.ucl.ac.be! . We are grateful to Duncan Black and John Conley for their useful suggestions. The second author acknowledges financial support from the Fond national de la recherche scientifique ~Belgium! . Received August 2000; Accepted September 2000. © 2001 Blackwell Publishers, Inc. Journal of Public Economic Theory,3 ~1! , 2001, pp. 7–14. 7