Effect of conformism on firm selection, product quality and home bias

This paper investigates the impact of local traffic pollution on the formation of residential and
business districts. While firms benefit from local production externalities, households commute
to their workplaces with private vehicles and exert a local pollution externality on the
residents living along the urban transport networks. The spatial location of firms and residents
endogenously results from the trade-off between the production and pollution externalities
and the commuting costs. The analysis shows that in monocentric cities the benefits
associated with a fall in per-vehicle pollution are absorbed by rents paid to absentee landlords.
When a city includes business and residential districts as well as a district mixing both
agents, a lower per-vehicle pollution enlarges the residential districts and shifts the business
districts closer to the geographical center of the city. The paper finally studies the optimal
city structure. The first-best policies that fully internalize the externalities still foster business
agglomeration.