ECONOMIC ANALYSIS

The external economies and diseconomies of land use mean that urban property markets have uncompensated externalities that result in unrestricted markets not functioning in such a manner as to achieve Pareto optimality.
It is generally consider obvious that the presence of external effects in the urban property market drive the desire for zoning. In other words, if one happened to own a house for their own residential use and a meat packing plant wanted to move on to the adjacent lot, it would no doubt be upsetting because of the possible odors, noise, congestion, etc., which might lower the property value of the house.
In fact, all zoning restrictions – use, height, area and density are efforts to eliminate possible externalities which are generated by uses or property features that might impose undesirable effects upon other properties in the area.
An external economy will increase the value of affected properties and external diseconomies will decrease the value of affected properties. If one neighbor decides to repaint his house and spruce up his yard so he can get a better price when selling it, he also at the same time is slightly improving the market value of other houses in the neighborhood, creating a “external economy” benefiting his neighbors. On the other hand, another neighbor who is a grade-A slob and lets the external appearance of his house run down creates an "external diseconomy" by depressing the attractiveness and thus the market value of the whole neighborhood.
Most of the critiques of zoning fall into four broad categories. Two concern fairness or equity and the other two are based on considerations of economic efficiency. Zoning is said to be: (A) unfair because it benefits some landowners at the expense of others; (B) exclusionary, and therefore unfair to those excluded from a particular community; (C) inefficient insofar as it adds large transaction costs to development decisions, outweighing the benefits (if any) of zoning; and (D) inefficient in that it "distorts" land use allocation decisions, resulting in inefficient patterns of land use.
Ultimately, resting a defense of zoning upon the controversial and unverifiable claim that these consumer surpluses are always (or even usually) sufficiently large to make zoning an efficient welfare-maximizing institution is difficult. However, the case against zoning on efficiency grounds is also not clear-cut once the consumer surplus is taken into account. Given that we are necessarily uncertain about which course of action will maximize aggregate welfare, it is reasonable to choose a course, zoning, that would simultaneously protect the stability of existing neighborhoods and likely maximize the welfare of current neighborhood residents.