Transcript Chapter 4

Quigley JEP (1998)
• Survey on economies of scale and growth:
Factor
Example
1. Scale Economies
In Production
Larger plant size
In Consumption
Public Goods, parks, sports auditoriums
2. Shared Inputs
In Production
Repair, accounting, legal, advertising
In Consumption
Theater, restaurants, high/low culture
3. Transaction Costs
In Production
Labor market matching
In Consumption
Shopping districts
4. Stat. Economies
In Production
Resale market for assets
In Consumption
Substitute goods
Glasear JEP (1998)
• Summarizes economies of scale to asses the
demand for cities in the future.
• Will cities disappear or continue growing.
• Agglomeration Economies:
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Scale economies in transportation and production
Labor pooling
Informational Spillovers at city level
Worker’s Productivity Enhancement
Face to face interactions
Glasear JEP (1998) (Cont.)
• Congesting forces:
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Higher costs of living
Higher Commuting costs
Pollution Costs
Crime
Selective migration (poverty)
The Size of the City (3 steps)
• The size of the city is determined thus by:
– Localization economies: Different intensities across
industries yield cities of different sizes
– Urbanization economies: Firms under urbanization
economies are attracted to big urban areas,
enhancing the differences
– Consumer spending: Bigger cities support more
products
So far we have seen:
• Why do cities exist?
– Economies of Scale in Production
– Economies of Scale in Transportation
• What determines the size of the city?
– Localization Economies
– Urbanization Economies
– Shopping Economies
• TODAY: Understand where cities exist by
looking at the location decision of firms.
Holmes and Stevens
(Handbook of Urban Economics, 2003)
Holmes and Stevens
(Handbook of Urban Economics, 2003)
Holmes and Stevens
(Handbook of Urban Economics, 2003)
Chapter 4
Where do Firms Locate?
Goal of the Lecture
• Study the location decision of the firm
• The location decision of the firm is based on Profit
Maximization:
• Transportation costs
• Local Inputs
• Localization Economies
• Urbanization Economies
• Taxes
• Public Goods and Services
Transfer Oriented Firms
• Transportation costs are the main type of costs.
• Firm chooses location:
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min Transport Cost=Procurement Cost + Distribution Cost
X- Distance between firm and input source
Xm-Distance between input source and market location
Procurement Cost: witiX
Distribution Cost: woto(Xm-X)
wj Physical Weight; tj Transportation rate
wjtj Monetary Weight
Assumptions of the Model
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Single transferable input
Single transferable output
Fixed factor proportion
Fixed Prices
Firm problem becomes to choose a X s.t.:
min witiX-woto (Xm-X)
Resource Oriented Firm
• witi>woto
• Firm’s location is close
to input source
• In general if the input is
bulky, perishable, fragile
or hazardous.
• Examples:
– Baseball bats
– Canned Fruit
$
Total Transportation Cost
Procurement Cost
Distribution Cost
Input Source
Market
X Distance to Input Source
Market Oriented Firm
• witi<woto
• Firm’s location is close
to the market.
• Output is bulky,
perishable or hazardous.
• Examples:
– Automobiles
– Bakery
$
Total Cost
Procurement Cost
Distribution Cost
Input Source
Market
Distance to Input Source
The Principle of Median Location
• Remove the assumption of single output or
single market
• Assume that the city is a straight line
• Firm distributes output to consumers in
different locations
• What location will the city choose?
The Principle of Median Location
• The optimal location for the firm is the one that
splits the number of consumers in two equal
halves
Distance
A
B
C
Costumers
2
8
1
D
E
F
G
H
I
• Where would the firm locate? Point C
• Move to D: Gain 10x$t ; Loss 11x$t
• Move to B: Gain 10x$t ; Loss 11x$t
J
10
K
The Principle of Median Location
Distance
A
B
C
D
Costumers
4
4
4
4
E
F
G
H
I
• Where would the firm locate? Point K
• Move to J: Gain 16x$t ; Loss 17x$t
• Move to D: Gain 16x7x$t ; Loss 17x7x$t
J
K
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Transportation Costs and Labor Market
• Firm locates close to market and input source
$
Total Costs
Transportation Costs
Labor Costs
T
Distance from Market and Input Source
Transportation Costs and Labor Market (Cont)
• Firm locates away from market and input
source.
$
Total Costs
Transportation Costs
Labor Costs
T
Distance from Market and Input Source
Group Discussion (4 people to a group)
• Rank your city by size (Population)
• What are the localization and urbanization
economies in your city?
• Does your discussion correctly predicts the rank
size of the city?
The Role of Government
• Economic Development Programs:
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Property-tax abatements
Low interest loans
Wage subsidies
Free land and infrastructure
Services to improve productivity
Bartik, Timothy J. “Jobs, productivity, and local economic development: What
Implications Does Economic Research have for the Role of Government,”
National Tax Journal, Dec 1994, 47(4), pp 847861.
Are Programs Efficient? Discussion
• Program should exits only if there exists a
Market Failure
• Ideal World; w=w* → wt ≥ PC
• Does Marginal Benefit=Marginal Cost?
• Underinvestment of information and knowledge
of small firms?
• Are new jobs in one area, lost jobs in another?
• External Spillovers?