Abstract

This paper shows that a city where both a congestion externality and an externality from greenhouse gas emissions are corrected by efficient policies is more compact than the laissez-faire equilibrium city. Motivated by recent empirical studies showing a positive relationship between population density and vehicle fuel-efficiency, the consumer is assumed to choose vehicle fuel-efficiency jointly with housing consumption and residential location. By incorporating the consumer׳s vehicle choice into the urban spatial model, we can represent the total amount of vehicle emissions released by the city residents. We first establish the well-known result that the congestion externality as a source of market failure is associated with excessive urban sprawl. We then show that vehicle emissions are an additional source of market failure, which also leads to excessive urban sprawl. The source of excessive sprawl arising from the emission externality is the use of larger and less-fuel efficient vehicles in more sprawled cities, which is different from that of the congestion externality. We also analyze the effect of the Corporate Average Fuel Economy (CAFE) standards on urban spatial structure and its efficacy as a second-best tool for correcting the emission externality.