Regional Economics - Part I - Theories of local development (Physical metric space)

REGIONAL ECONOMICS

INTRODUCTION + PART I - LOCATION THEORY: PHYSICAL - METRIC SPACE. (Chapters: 1,2,3)

INTRODUCTION

1. Economics and space.

Economic activity arises, grows and develops in space. Firms and economic actors choose their locations in the same

way as they choose their production factors and their technology. Productive resources are distributed unevenly (irre-

golarmente) in space. Quantitative and qualitative imbalances in the geographical distribution of resources and eco-

nomic activities generate different factor remunerations, different levels of wealth and well-being, and different de-

grees of control over local development. Space influences the workings of an economic system. It is a source of eco-

nomic advantages (or disadvantages) such as high (or low) endowments of production factors. The geographic distri-

bution of resources and potentials for development is only minimally determined by exogenous factors (raw materials,

natural advantages). To a much larger extent it results from past and recent historical factors: human capital, social fi-

xed capital, fertility of a land and accessibility. Regional economics is the branch of economics that incorporates the

dimension “space” into analysis of the workings of the market. It does so by including space in logical schemes, laws

and models that regulate and interest the formation of prices, demand, productive capacity, levels of output and deve-

lopment, growth rates and the distribution of income in condition of unequal regional endowments of resources.

What is regional economics?

Younger ranch of economics compare to others.

Formed in 1956 when was published a book written by Walter Isard “Space Economy”.

Idea: Economy and Spaces.

It was underlined the importance of Space Economics.

Transactions —> exchange of goods.

Regional Economics is about the fact that these agreements for finding the right price to buy and sell the goods,

change according to the area that you are located in.

Consideration of space by economists:

1. Walter Isard it has been due to the decisive infl uence of the neoclassical school, which has conceived the tempo-

ral analysis of economic development as crucial and neglected the variable “space” as consequence often in order

to simplify the treatment. As Alfred Marshall wrote: “The diffi culties of the problem depend chiefl y on variations in

the area of space, and the period of time over which the market in question extends; the infl uence of time being

more fundamental than that of space”.

2. The treatment of variable space in economic analysis complicates the logical framework. The analytical tools until

recently available to economists could not handle temporal and spatial phenomena like agglomeration or proximi-

ty economies.

Regional Economics seeks to answer the following fundamental questions:

What economic logic explains the location choices of firms and households in space?

• What economic logic explains the configuration of large territorial systems? (ex. cities)

• Why are certain areas more developed than others?

•

Two main groups of theories that make up regional economics tried and try to answer these questions.

Regional Economics is divided in 2 big area:

1. LOCATION THEORY: (Chapter 1-3)

2. REGIONAL GROWTH (AND DEVELOPMENT) THEORY (Chapter 4-9)

1. LOCATION THEORY: The oldest branch of Regional Economics, fi rst developed in early 1900s which deals with

the economic mechanisms that distribute activities in space.

Location theory gives regional economics its scientific-disciplinary identity and constitutes its theoretical-methodolo-

gical core. It has typically microeconomic foundations and it adopts a traditionally static approach. It deals with the lo-

cation choices of firms and households (explain why people or firms have chosen to be located in one point in space

with respect to another point) and analysis of disparities in the spatial distribution of activities.

Linked with it are a variety of metaphors, cross-fertilisations and theoretical inputs which have refined the tools of re-

gional economics and extended its range of inquiry. Location theory uses the concepts of externalities and agglomera-

tion economies to shed light on macro-territorial phenomena as disparities in the spatial distribution of activities.

Why people choose their house or firms location? (Economic reasoning in terms of location).

Physical element (created by architects and engineers) that influence the choice of location?

Theory that deal to location choices for firm and house.

Why and Where? Concentration of activities in space. People, firms (Area).

2. REGIONAL GROWTH (AND DEVELOPMENT) THEORY:

Focuses on spatial aspects of economic growth and territorial distribution of income. Regional growth theory is intrin-

sically macroeconomic. But it differs from the purely macroeconomic approaches od political economy in its concern

with territorial features. (Different types of situations and different types of drivers)

2. Location and physical metric space.

The first and earliest group of theories in regional economics calls under the heading of “location theory”. This group

adopts a geographical conception od continuous “physical-metric space” definable in terms of physical distance and

transportation costs.

1. AGGLOMERATION AND LOCATION

1.1. Agglomeration economies and transportation costs

Space is inextricably bound up with economic activity: all forms of production require space. But not all geographical

areas afford the same opportunities for production development. The uneven distribution of raw materials, production

factors (capital and labour) and demand (final good markets) requires productive activities in general (es. firms) to se-

lect their locations just as they select their production factors and technology. This decisively influences the productive

capacity of firms and their position on the market, so location crucially determines the productive capacities of firms

and of the geographical areas in which they are located.

LOCATION THEORY

For regional economics is important to consider the place (where?)

The notion of space was introduced by theories of industrial location, the aim was to explain location choices by

considering the two great economic forces that organise activities in space:

1. TRANSPORTATION COSTS (go where consumers/markets are) —> push to distribution in space

2. AGGLOMERATION ECONOMIES (the economies concept is savings - fare economia)

Save money thanks to agglomeration. Concept of co-locate: create agglomeration.

These two forces push the location process in opposite directions since they simultaneously induce both the disper-

sion and the spatial concentration of production.

AGGLOMERATION ECONOMIES: Concentration of activities in space

3 types of Agglomeration economies:

I. Economies of scale: Size of firm.

ADVANTAGES comes from large space production process.

The advantages of this category derive from the pure concentration of activity in space.

Costs (of any types) are lower / savings because of the size.

TOTAL COST / Y (volume of production) = AVERAGE COST

TOTAL COST / INHABITANTS = AVERAGE COST (f.e. underground)

TOTAL COST = FIXED COSTS + VARIABLE COSTS

Something costs less because of the size of the production. Large units - Fix cost drops drastically. Ex. cars.

MetroLine: why only large cities have metro? because they can afford it!

In order to built the underground and manage it and maintain it you need a lot of people that use it everyday!

The larger is the production the lower are the prices.

The advantage that firms have is: the higher the size/production of the firm the higher the economic advantage.

II. Localisation Economies: Size of Industries (settori)

Determines by the size of the sector in a particular area with a wide range of specialised suppliers and in which

skilled labour and specific managerial and technical expertise are available.

Location in an area densely populated by firms operating in the same sector.

ADVANTAGES: given by the industry (sector).

The larger the number of fi rms belonging to a sector, the more they create a localisation advantages.

Why? because they can share among their self a lot of costs, that otherwise must be taken in consideration by just one

Cost reduction: the labour market is highly specialised in what they are looking for.

So it means that, for each fi rm, the quantity of product is produced (y) depends on:

y = F (La, Ka)

La = Number of people that work in that fi rm

Ka= the Capital that the firm has.

Efficiency: one fi rm produces the same quantity of good with less input.

III. Urbanisation Economies: Size of a city.

Urbanisation economies derive from the high density and variety of productive and residential activities in an area;

features which typify urban environments.

ADVANTAGES comes from been located in an urban area/urban environment, for the presence of large-scale

fixed social capital and a broad and diversified intermediate and final goods market.

—> Mix of services and activities

The larger the city, the higher the advantages.

—> High level of services provided.

These 3 types of economies’s advantages are the reason why we have agglomeration in space. However, there are

two forces that work in the reverse direction and give rise to dispersed location.

So we have the formation on the agglomeration area of INCREASING COSTS and DISECONOMIES:

- prices of less mobile and scarcer factors (land and labour)

- the congestion costs (noise, air pollution, crime, social malaise) distinctive of large agglomeration

These diseconomies are generated above a certain critical threshold. At a certain level the advantages could become

disadvantages (in size of a city).

The second important concept (the first is 'agglomeration economies') is 'transportation cost', the cost of moving on

space. And this is not only a financial cost (ex. the ticket that i have to pay to go...) but it also what is called in econo-

mics the cost of taking time to do somethings and this time I could spend it to do somethings else. The opportunity

cost is the cost of spending time to do something, that the same time, could be spent to do something else. Under

'transportation cost' we have the 'financial cost' but also and especially the 'opportunity cost' of spending time to

move in space that I could instead use to go somewhere else. Transportation costs are of greater interest because the-

se costs countervail the spatial concentration of activities whatever level of agglomeration has been reached.

The theory of localisation defines “transportation costs” as all the forms of spatial friction that five greater attractiveness

to a location that reduce the distance between two point in space.

Transportation costs are:

- the economic cost of shipping goods

- the opportunity cost represented by the time taken to cover the distance which could instead be put to do some-

thing else

- the psychological cost of the journey

- the costs and difficulty of comunication over distances

- the risk of failing to acquire vital information

Transportation costs are therefore essential to location theory for they differentiate space and enable its treatment in

economic terms. They are comprised in the concept of agglomeration economies as the costs of interaction and

distance. In this sense, agglomeration economies are “proximity economies” they are advantages that arise from

the interaction among economic agents made possible by the lower amount of spatial friction in concentrated

locations.

So we have 'agglomeration economies' and 'transportation cost', and these two forces explain the location of activities

all over space.

Two different group of theories on the location of industrial activities can be identified on the basis of objectives

that they set themselves, and according to the hypothesis that they assume about the spatial structure of the market:

1. COST MINIMISATION THEORIES.

These suppose a punctiform outlet market and a punctiform source of raw materials supply located at different

points of space, in order to investigate the location choices of fi rms at minimum transportation costs.

These theories are based on a partial equilibrium framework.

Cost minimisation theories offer answers to questions such as:

- Given the price and the location of raw materials and the outlet market, where does the firm locate?

- How do location choices change when one hypothesises a place in which agglomeration economies exists?

2. PROFIT MAXIMISATION THEORIES

These theories account for the division of the market among several fi rms in terms of profi t maximisation based on

the hypothesis that demand is geographically dispersed and supply is concentrated in some points of the market.

They assume that the area of each fi rms’ market and its location depend on consumer behaviour and on the loca-

tion choices of other fi rms. These theories are conceived largely within a partial equilibrium framework; with the

exception of Lösch’s Model, which envisages a general spatial equilibrium (several fi rms simultaneously in econo-

mic-location equilibrium).

Profit Maximisation theories offer answers to questions such as:

- Given a certain spatial distribution of demand, how deforms divide up the market?

- Once the firms’ location is defined, how does it change with variation in the initial production conditions or in the lo-

cation choices of other firms?

1.2 Localisation economies and transportation costs.

1.2.1. Weber’s Model

One of the first and best-known studies on the spatial concentration of industry dates back to 1909. Alfred Weber

constructs an elegant location model where the costs of transportation among production site, raw materials

markets and the final goods markets (which together define a minimum transportation cost) are directly compared

against localisation economies.

The prevalence of one element over another determines the geography of industry location.

Weber reasoned in 2 steps in order to define how firms decide they location.

- First step: the firm chooses the location in order to minimise its total transportation cost.

- Second step: the firm compare the advantages of agglomeration (localisation economies) against the higher

transportation cost associated to a possible change of location.

Spatial distribution:

SUPPLY = Punctual -> ‘M1’ e ‘M2’

DEMAND = Punctual -> ‘C’

AIM: Find out the best location for a firm that has yo serve a punctual final market.

Weber’s model is based on the following assumptions:

a) there is a punctiform market for the good (C in figure)

b) there are two (punctiform) raw materials markets, located at a certain distance from each other (M and M )

1 2

c) there is perfect competition in the market

(fi rms are unable to gain monopolistic advantages from their choice of location)

d) demand for the final good is price-inelastic (price-inelastic: when price of a good changes but the quantity of

the good demanded, or supplied, varies less than proportionally or remains the same).

e) the same production technique is used in every possible location, so production costs are given and constant.

1. FIRST STEP: LOCATION THAT MINIMISE THE (TOTAL) TRANSPORTATION COST

Production factors: in order to produce:

- People

- Plant/Equipment y = (L, K, Intermediate goods)

- Capital

- Intermediate goods

We have to consider where the product of intermediate goods are located, and where the people (market) that buy

the final product are located.

TOTAL TRANSPORTATION COST = ax + by + cz

Where:

P is the fi rm)

a, b and c are the distance that the fi rm has to cover to go and buy

the material in M1 and M2 and then to go to the fi nal market in C

(consumers)

x: are the tons of gum that have to be transported in order to pro-

duce one chair

y: are the tons of wood that have to be transported in order to pro-

duce one chair

z: are the tons of chairs that are produced.

So the question of Weber is that of course the logic of the fi rm is that the transportation cost are equal to:

- The firm can locate itself in the location (triangolo). x, y, z are the tons of product that have to be transported.

- If: x, y, z weight the same —> The firm can locate in the CENTRE of the triangle

- If: x is light and y is heavy -> you minimise the transportation cost by putting the firm near to M1

IT’S NECESSARY TO GUARANTEE

THE MINIMUM TRANSPORTATION COST.

HOW? Weber did it empirically.

If x,y,z are equal => is correct to locate the production in the middle.

• If x is very light (minor cost) and also z is in very light (for transportation) instead y is heavy

• => P is better to be located near M2 and so on.

Practical demonstration: Weber bring a board that has a triangular shape (the location triangle), makes 3 holes in the

vertexes, M1, M2 and C, and uses 3 ropes. The 3 ropes pass into the holes and they are then linked together with a

knot -> the knot is the point ‘P’. Then he attaches 3 weights to the vertex (x, y and z), that are proportional to the cost/

km of distance. Then the board can du things:

Assumes a slope and the point ‘P’ be closer to a certain vertex.

• Point ‘P’ stays perfectly in the middle because there is an equilibrium -> all weights are the same.

•

In this very practical way, Weber finds the point of minimum transportation cost.

Does the firm remain in that point?

So Weber model, in its first step, can lead to 3 situations:

1. If (x + y), z weight the same —> The firm can locate in the centre of the triangle

2. If x + y is heavier (più pesante) than z —> The firm can locate closer to M1 or M2 (Raw material market)

This happens for example when a product, after the processing, looses weight.

So the cost of transportation a finished good from site ‘P’ to the final market ‘C’ is lower than the cost of transpor-

ting all the raw materials to the site ‘P’. (ex. Marble rocks).

This kind of location is called “Raw materials oriented”.

3. If z is heavier than x + y —> the firm establishes closer to ‘C’ corner “Market oriented”

SECOND STEP

Compare the advantages of agglomeration (localisation economies,