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:

– 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:– 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: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

• 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

X Distance to Input Source

$

Procurement CostDistribution Cost

Total Transportation Cost

X Distance to Input Source

Procurement CostDistribution Cost

Input Source

Market

Market Oriented Firm

• witi<woto

• Firm’s location is close to the market.

• Output is bulky, perishable or hazardous.

• Examples:– Automobiles– Bakery

Distance to Input Source

Market

$

Procurement CostDistribution Cost

Total Cost

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

• 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

Distance A B C D E F G H I J K

Costumers 2 8 1 10

The Principle of Median Location

• 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

Distance A B C D E F G H I J K

Costumers 4 4 4 4 17

Transportation Costs and Labor Market• Firm locates close to market and

input source

Distance from Market and Input Source

T

$

Transportation Costs

Labor Costs

Total Costs

Transportation Costs and Labor Market (Cont) • Firm locates away from market and

input source.

Distance from Market and Input Source

T

$

Transportation Costs

Labor Costs

Total Costs

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:– 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?