An integrated model of formal and informal housing sectors

Many cities in developing countries are characterized by a striking juxtaposition of formal and informal housing, where these sectors coexist in close proximity. This paper develops a model of urban land markets where both the formal and informal sectors are endogenously and mutually determined. More specifically, the informal market arises as a kind of residual effect of decisions made in the formal sector. The model posits a fixed number of rich and of poor households, all of whom are competing in the marketplace for a place to live. Rich households enact formal land use regulations in the form of minimum lot size requirements that directly reflect their preferences. The impacts of these regulations on the informal sector depend upon relative incomes and populations of poor and rich households, as well as on housing preferences. In order to assess these impacts empirically, the paper formulates a set of stylized case studies. The model results illustrate that the formal and informal sectors do not exist independently from one another, but are instead dual aspects of a single market phenomenon. In particular, an insufficient absorptive capacity of the formal sector results directly in informality.