At first blush, cities make no sense. If we just look at costs -- the cost of land, the cost of congestion, the cost of crime -- no one should live in cities. Everyone should just get a house in the countryside and live a comfortable distance from everyone else. Ditto for businesses. Business inputs invariably cost more in cities. Move to a rural location and cut the cost of those inputs. If cities were simply the accumulation of production factors, they should fly apart.
Some people do live in the countryside and some businesses do relocate where land is cheap, of course. But cities do exist. Why?
Urban economists have two theories.
One theory is that agglomerations of people or businesses or factories sometimes produce increasing returns. They collectively produce more than they would if dispersed, each hanging out on his own.
The other theory is that cities are held together by the amenities they offer. Concentrating people in a relatively small region produces increasing returns for retail because shops can specialize. New York city has a wedding store that caters to pregnant women, for example. Not everyone counts that as an amenity, but that's the point. Big cities can support lots of tiny markets, which makes specialization profitable.
Both theories might hold. But they pull in opposite directions. If cities mainly exist because they make people more productive, then wages should be higher than the countryside. That, in turn, must drive up the price of land. (Land must become more expensive to offset the higher wages else everyone would move to a city.) But if cities mainly exist because of the amenities they offer, wages should be lower (relative to the price of housing) because workers should be willing to substitute amenities for wages.
It is commonly noted that there is an urban wage premium, perhaps because of agglomeration effects on productivity, or to compensate (in utility terms) for higher traffic and land costs. S. Lee presents evidence that, at least in some fields, there is a negative urban wage premium for high skill workers. The story is thus: high skill workers have greater taste for variety in consumption, and cities provide such variety; if the extra utility from consumption variety grows faster than rents, and utility is equal in rural and urban areas, then urban areas could show lower wages for high skill workers. Since high skill workers are relatively cheap in cities, they will be used in firms in higher proportion than low skill workers. Data on the medical profession bears this out: hospitals use a higher ratio of doctors to nurses in cities, the doctors are paid less in real terms in cities, and the nurses are paid more in real terms in cities than in rural areas. Further, these urban doctors tend to work in higher skill specialties, and be graduates of higher ranked medical schools, than higher paid rural doctors. This is yet more evidence of the consumer-driven rationale for cities: production is not everything.
Glaeser and Gottlieb have made the same argument using crime data. They've argued that the rejuvenation of cities -- and the rise in land prices in cities -- was driven largely by the stunning drop in crime. A city is a much more pleasant place when you don't have to worry about being mugged every time you walk down the street.