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Location of firms Location theory Location theory ◆ Location theory: What it does; -explains how and why firms and households make location decisions -describes why cities arise in particular locations and why some cities grow more rapidly than others ◆ Location decision of a firm -based on “profit maximization” -a firm’s potential profit varies across space Location theory ◆ 3 reasons for the firm’s profit variation over the space 1)transporting inputs and outputs .input or market orientations 2)localization and urbanization economies external to the firm 3)local public services and taxes; e.g., schools, mass transit, and other infrastructure services Transportation of inputs and outputs ◆ Basic assumptions -firms choose the location that minimizes total transport cost – sum of procurement and distribution costs -4 assumptions for a model; .single transferable output .single transferable input .fixed factor proportion (no factor substitution) .fixed price or market determined price for both inputs and output Transportation of inputs and outputs ◆ the Model -max. profit=TR(=p x q)-TC(=input cost+transp cost) .only costs that vary across space are procurement costs and dist costs, and the outcome of a tug-of-war btwn the two determine the firm’s location -the closer toward input source, the lower the procurement cost; but proximity to market helps reduce the firm’s dist costs. I. Input or market orientation 1.1. Resource/input oriented firm -key decision factor: tug-of-war btwn the monetary weights (MW) of firm’s input and output .MWi > Mwo; then, resource oriented firm Figure 1: Resource oriented firm (bat producer) $ 00 80 Total transport cost = PC + PD 60 Procurement cost (PC) 40 Market(M) 20 Distribution cost (DC) 0 2 4 6 8 10 distance from forest in miles) Forest (F) Input orientation .PC = wi.ti.x where w: physical weight t: transport cost/km x: distance btwn input site and factory .DC = wo.to.(xm-x) xm: distance btwn factory and market Input orientation -in figure 1, total transport cost is minimized at the input site at $60 .i.e., the monetary weight of the input exceeds that of the output (weight losing activity) .tug-of-war won by the input source -other examples; .beet-sugar factory located near beet farms .ore processor near mines: use only a fraction of the materials extracted from the ground Input orientation -other reasons for resource orientation .inputs either too expensive to transport (raw fruit for canning) .inputs perishable, bulky, fragile or hazardous (soybean for Kikoman, vegetable oil, other food processing factories located close to farms) Market orientation 1.2. Market oriented firms -relatively high costs for transporting its output to the market (e.g. bottling firm) -involved in weight gaining activity .the monetary weight of the output exceeds that of the input; market oriented. Market orientation - Figure 2: Market oriented firm $ 5 4 3 Total transport cost = PC +DC Distribution cost 2 Procurement Cost Market (M) 1 0 2 4 6 8 10 Distance from input sourc e Sugar plantation (F) Market orientation -figure 2 shows weight gaining activity .the tug-of-war btwn input source and market is won by the market -other examples; .outputs are bulky, perishable, fragile and hazardous (e.g. bakery) * What happens if constant average cost of transportation assumption does not hold? -scale economies occur because; 1)fixed cost of loading and unloading a shipment; 2)line-haul economies (e.g. a truck for short haul and train/ship for a long haul) -Thus, transport unit cost per km decreases with increase in distance or AC decreases with distance Input or market orientation 1.3. Principle of median location -defn: optimum location is the median transport location that splits the total monetary weight of the firm into two equal halves -use the principle when multiple inputs and markets involved .often ended up with large cities where demand is concentrated, causing them to grow continuously. Input or market orientation 1.4. Transshipment points and port cities -the principle of median location explains why some industrial firms locate at transshipment points, where goods are transferred from one transport mode to another (e.g. from train or truck to sea-born or air-born transport) -example: sawmill or logging as a weight losing activity, causing port cities to grow (e.g. Seattle, Baltimore, and Buffalo) Input or market orientation ◆ Any change in orientation due to energy cost and transportation technology? -energy: important in the location decisions as a transportation input .steam engine: energy intensive mfgers located along navigable waterways .electricity: decreased the importance of energy consideration in location decision II. Localization and urbanization economies 2.1. Definition -localization econ means clustering of firms in a location and urbanization econ. cost savings associated with large city location -thanks to both, firms locate in a large city to take advantage of; 1)inexpensive intermediate goods and services, 2) extensive knowledge spillovers and 3) large labor pool -both forces lead to self-reinforcing growth of cities Localization and urbanization economies 2.1. Labor market and location choices -incorporate labor cost into transport cost model, lead to two models: output market or labor oriented Figure 3: Output-market oriented firm (case 1) $ 50 Total cost = Transport cost + Labor cost 40 30 20 10 Labor cost Transport cost T 2 4 6 8 10 Distance from market and inputs (A) Firm locates close to market and i nputs Localization and urbanization economies -Labor oriented firm Figure 4: Labor (market) oriented firm (Case 2) $ 50 40 30 Total cost = Transport cost + Labor 20 Labor co cost st 10 j Transport c ost T 2 4 6 8 10 Distance from market and inputs (B) Firm locates far from market and i nputs Localization and urbanization economies -output market oriented firm (figure 3) .forces pulling the firm toward market stronger than those pulling the firm toward locations with low wages and labor costs -labor market oriented firm (figure 4) .decrease in the physical weight or unit freight cost causes the firm to locate far from the market where labor costs low -effects of transportation and production technology flatten the transport cost curve, causing the firm to switch from transport to labor orientation (e.g., assembly operations of US & Korean mfgers overseas) Localization and urbanization economies -more recent trend .firms follow high quality labor force, in knowledge industry in particular, that demands for amenities (which are high income elastic), causing exodus of firms into suburbia .knowledge based firms locate near universities where they can easily find qualified human capital of high learning and well informed; not uniformly distributed across the space! III. Local public services and taxes 3.1. Effects of taxes on location decisions and urban growth -negative because taxes are capitalized as costs to firms -but good quality public services improve bus. environment and productivity, which cost tax monies for local governments to provide. Local public services and taxes 3.2. two types of location decisions -intercity: choosing a city -intracity: choosing a site within a city * elasticity of business activity w.r.t tax liabilities ranges -.10 to -.60 for intercity location decision and -1.0 to -3.0 for intracity location decision, suggesting that different locations within a city are better substitutes than those in different cities Local public services and taxes -services with largest positive effects .education and infrastructure 3.3. Subsidies and incentive programs (tools for local economic development) -property tax abatement, leading to tax “shopping” -tax free industrial bond to finance developments -government low cost loans and loan guarantees -subsidizing site developments; land and public services -designation of enterprise zones *firms shop around for the best deal! 3.4. Attraction of professional sports club? IV. Some case studies 1) Semiconductor industry -different locations for R/D (at Silicon Valley), wafer fabrication (Az, Tx, Ut), and assembly- into-components (overseas) 2) Toyota automobile firm -JIT requires geographical proximity to input suppliers; just in time for production! -agglomeration is the key factor in the location choice Some case studies 3) GM’s Saturn plant: 5 step decision making process -issue of trans costs and market access -labor costs -State and local taxes -compare incentive packages offered -effects of wages and unions A Question ◆ Suppose that you are hired as a urban development consultant by your city’s mayor (whoever it may be). How would you go about urban development for the city that you live in or work for? Any strategic advices that you would give him or her in order to facilitate localization and urbanization economies?
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