Location of firms by nikeborome


									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
◆ 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
◆ 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)
       80       Total transport cost = PC + PD

       60                                         Procurement cost (PC)

                                                 Distribution cost (DC)


                         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
.DC = wo.to.(xm-x)
           xm: distance btwn factory and
          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
           Market orientation
- Figure 2: Market oriented firm



       3                                          Total transport cost = PC
                                                 Distribution cost
           Procurement Cost
                                                                          Market (M)

                       2          4        6         8        10
                             Distance from input sourc
      Sugar plantation (F)
              Market orientation
-figure 2 shows weight gaining activity
 .the tug-of-war btwn input source and market is won by the
-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
 -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
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
        Localization and urbanization
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




             10                                            Labor cost
                            Transport cost

                  T          2           4          6            8      10
                                Distance from market and inputs
                           (A) Firm locates close to market and i
      Localization and urbanization
-Labor oriented firm
 Figure 4: Labor (market) oriented firm (Case 2)




                                            Total cost = Transport cost + Labor
          20         Labor co                               cost

                   Transport c

               T             2          4           6          8         10
                                  Distance from market and inputs

                                 (B) Firm locates far from market and i
      Localization and urbanization
-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
     Localization and urbanization
-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
 .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
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

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