# Location of firms by nikeborome

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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?
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
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