| Abstract: | This paper shows that an incentive problem in investment can lead to an excessive concentration of economic activity. The incentive problem arises from the concern of developers for their reputations; they have a tendency to imitate each other′s location decisions because they fear denial of future credit if they make eccentric choices that do not work out. The excessive concentration can manifest itself in cities that are too large or in too many firms of one type choosing a location. In the extreme case, cities may exist in equilibrium even in the absence of agglomeration economies. The inefficiency can, however, be alleviated by an appropriate agglomeration tax. |
