Appunti sulle lezioni di Regional Economics + Land Rent Theories - I + II Parziale

Regional economics and land theory

10th March 2020

Regional economics

Regional economics became a discipline in itself only in 1956, when an important book appeared of the Professor Walter Isard, “Economy and Space”; he was the first one that has introduced the space consideration in economic.

Regional economic is not the study of the economy at the level of administrative regions, it is the branch of economics that incorporates the dimension space into analysis of the market.

The main focus of analysis when local growth models include space as an economic resource and as an independent production factor, a generator of static and dynamic advantages for the firms situated within it – or, in other words, an element of fundamental importance in determining the competitiveness of a local production system.

Key questions

Key questions that Regional Economics aims to answer:

• What economic logic explains the location choices of firms and households in space?
• What economic logic explains the configuration of large territorial systems, like city?

Answers to these questions have been put forward by two large groups of theory:

• I. Location theory. The oldest one, which deals with the economic mechanisms that distribute activities in space.
• II. Regional growth theory. Focuses on spatial aspects of economic growth and the territorial distribution of income.

Regional: subnational systems, they can be administrative area (Lombardia), or local district, city, region; the importance is not what they are but the fact that the area is not a country.

This part tries to understand which are the sources of grow: accessibility, transport infrastructure, quality of environment (physical).

It is analyzed the capacity of a Region to develop economic activities, to attract them and to generate the conditions for long-lasting development. The ability of a region to produce the goods and services demanded by the national and international economic system to which it belongs.

Concentration of activity in spaces, there must be reason for the concentration in space:

• Social Reasons;
• Economic Reasons, that at first influence where you are going to located.

Agglomeration space, two elements:

• Agglomeration: physical agglomerations of person/physical in a space;
• Economies, has the meaning of “saving”, “fare economie risparmiare”. If you are in an agglomeration you save money.

Location theory

This group of theories adopts a purely geographical conception of continuous, physical-metric space definable in terms of:

• Physical distance;
• Transportation costs.

It is another important concept that explain why we are concentrate in space.

They are all the forms of spatial friction that give greater attractiveness to a location that reduce the distance between two points in space.

Cost of moving in space, not only a financial cost but above all an opportunity cost: represented by the time taken to cover the distance which could instead be put to other uses.

Location theory seeks to explain the distribution of activities in space, the aim being to identify the factors that influence the location of individual activities, the allocation of different portions of territory among different types of production, the dividing of a spatial market among producers and the functional distribution of activities in space.

In this branch we can find all the theories that explain the location choices of firms and households; but also the analysis of disparities in the spatial distribution of activities.

Externalities: there are physical elements that influence the choice of location, these elements are produced by engineers and architects; so people that are not economists.

Location choices are interpreted by considering only the great economic forces that drive location processes:

• Transportation costs, which diffuse activities in space;
• Agglomeration economies, which instead cause activities to concentrate.

By balancing these two opposing forces, these models are able to account for the existence of agglomerations of economic activities even on the hypothesis of perfectly uniform space.

Agglomeration Economies have three mechanism:

• Economies of Scales: advantages are higher the largest is the firm;
• Economies of Localization: advantages are higher the largest is the size of the sector area;
• Economies of Urbanization: advantages are higher the largest is the city.

This is why we have agglomeration of people and activity in space. Space is inextricably bound up with economic activity because all forms of production require space.

Economies of scales - size of production

I. Economies of scales - Size of production

These arise from large-scale production processes yielding lower costs per unit of output: the largest they produce the lower cost the production.

Examples:

Cars industry: if fiat would produce one single car the cost would be too high, because there’s a lot of fixed costs, that are independent from the size of production, so if fiat produce millions of cars per year the cost of one single car drops drastically.

Metro line, this is the reason why only big cities have metro, little cities also need metro but they cannot afford it.

In order to built and maintenance the service you need a lot of people that use it every day, so you can divide on a high number of people the cost of maintenance.

This is also why we have a lot of hospital and airport in big city, they are characterized by indivisibilities: in order to produce even one single piece, you need a huge production chain, you cannot divide the production. Even if you have 2 metro for hour you have to build all the infrastructure system.

BA Output of the production process

Y = f ( L + K )

A A A

Labor Capital: physical + financial

A: 50 = 2 , 2 Firm A exploits the advantages of the localization economy, therefore it will

B: 48 = 2, 2 obtain a greater output than firm B

Localization economies – size of sector

II. Localization economies – Size of sector

These come from location in an area densely populated by firms operating in the same sector. The key point is the size of the sector that is present in an area.

For example an area dedicated at all to texture industry, in this area all the different industry could have an advantage that comes from the localization.

The firms located in the same area has an higher probability two found the persons that they are looking for with a lower price, also the cost of training is lower.

So activities that are close each other gain advantages, are more efficient: produce at a lower cost.

Urbanization economies – size of the city

III. Urbanization economies – Size of the city

The larger is the city: the higher are the advantages for people.

The advantage of being part of an urban environment.

These derive from the high density and variety of productive and residential activities in an area; features which typify urban environments.

Also persons have advantage in life in cities, for all the services that they can found.

Firm produce at lower cost or people increase their personal benefit utility. Everyone wants to maximize the utility.

We decide to buy a good if it provide us an advantage, maximize our utility, maximize our profit.

NB: CON of living in the city: Congestions costs, all the services that comes from urbanization economies deals with congestions costs. When congestion cost became higher people could decide to living outside city.

However, there are two forces that work in the reverse direction and give rise to dispersed location:

• I. The formation of increasing costs or diseconomies: the prices of less mobile and scarcer factors (land and labour), congestion costs (noise and air pollution, crime, social malaise) distinctive of large agglomerations.
• II. Transportation costs countervail the spatial concentration of activities whatever level of agglomeration has been reached.

The theory of localization defines ‘transportation costs’ as all the forms of spatial friction that give greater attractiveness to a location that reduce the distance between two points in space:

• Production site and the final market; place of residence and the work-place; raw materials market and the production site.

So transportation costs are:

• Economic cost of shipping goods (the pure cost of transporting and distributing them);
• Opportunity cost represented by the time taken to cover the distance which could instead be put to other uses; the psychological cost of the journey; the cost and difficulty of communication over distances; the risk of failing to acquire vital information.

Transportation costs are therefore essential to location theory in its entirety, 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: if transportation costs were nil, there would be no reason to concentrate activities, because doing so would not produce ‘economies’ (fare economia = risparmiare).

In this sense, agglomeration economies are proximity economies, advantages that arise from the interaction among economic agents made possible by the lower amount of spatial friction in concentrated locations.

In conditions of perfect competition, perfectly mobile production factors, fixed raw materials and demand perfectly distributed across the territory, the existence of transportation costs may erode the advantages of agglomeration until activities are geographically dispersed and the market becomes divided among firms, each of which caters to a local market.

Two distinct groups of theories on the location of industrial activities:

• Cost minimization theories, these hypothesize 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 firms at minimum transportation costs.
• Profit maximization theories, demand is geographically dispersed and supply is concentrated in some points of the market, these theories account for the division of the market among several firms in terms of profit maximization.

Location models

Alfred Weber’s model (1909)

The goal of the model is answer to “Where should a firm chose to be located in a space?”

The answer is that it depends on the balance between transport costs and agglomeration economies.

To compare additional transport costs and agglomeration economies which alternative locations (where transport costs are not minimized) could offer.

Model assumptions:

• There is a punctiform market for the good C;
• There are two raw materials markets, located respectively in M1 and M2;
• The is perfect competition in the market;
• Demand is price-inelastic, when the price of a good changes but the quantity of the good demanded (or supplied) varies less than proportionally or remains the same;
• The same production technique is used in every possible location. Production costs are therefore given and constant;
• Transport costs shall be linear and proportional to distance.

The localization choice results from a complex calculation performed in two stages:

1. Identify the location that minimizes transportation costs

CT = ax + by + cz

• X, y are the quantities of input (x and y);
• Z is the quantity of final good (z);
• A, b are the distances between the input market at the place of production;
• C is the distance between the place of production and the market of the final good (C).

The minimum cost location solution can be identified:

I. ax + by = cz Equilibrium condition of the forces of attraction.

None of the ‘forces of attraction’ exceeds the sum of the other two.

In economic terms, this situation occurs when the cost of transporting the z tonnes of the good one kilometer further away from the outlet market is less than the costs of transporting the x and y tonnes of raw materials away.

In these conditions, the location of P guarantees a minimum total transportation cost.

II. cz > ax + by Market oriented Point P must shift towards C.

III. cz < ax + by Raw Material oriented It must shift closer to the raw materials markets.

2. The firm compares the least-cost location with an alternative one where it can enjoy localization economies:

Assuming that P = point where CT is minimum

Around point P we can draw a circle called: isopadane curves along which the additional transportation cost that the firm must pay in order to cover a certain distance from the least-cost location remains constant.

Where the radius “v” means the advantage obtained by agglomeration.

F = additional transportation cost of the new location

V < f farm doesn’t move

Best condition: v > f

If it moves to another location there’s advantages that come from a lower CT.

Advantages:

• For the first time this model was able to accommodate agglomeration and transportation cost together, in the same model.

Limits:

• Static model, the model identifies the least-cost location on the basis of productive efficiency, but it ignores dynamic aspects such as innovation at the microeconomic level, while, at the macroeconomic one, it neglects changes in income distribution and in the relationships among agglomeration advantages, rents and wages.
• Transport oriented model, everything is based on CT. This is still true for heavy production.
• Its abstractness, which makes the least-cost location difficult to calculate in real settings.
• Its nature as a partial equilibrium model which entirely neglects possible interactions among firms;
• Its supply-side bias, the criticism most frequently made of the model is that it is excessively oriented to the supply side; it makes no mention of demand factors, assuming that demand is unlimited and inelastic to price variations.

Market size and transportation costs (Greenhut’s model)

Weber’s model ignores large urban agglomerations whose existence is due to the advantages, urbanization economies, that residential and productive activities obtain:

• People: these advantages are the availability of a wide range of services, from recreational amenities (cinemas, theatres) to transport facilities (international communication hubs, airports and stations).
• Firms: these advantages are broad and diversified markets for production factors and final goods, a concentration of social fixed capital and the efficient production of public services.

Greenhut aim and result:

• Analyses of how the size of the market determines the location of industrial firms.
• He finds that not always firms decide to locate in the region with the least distance between the final market and the raw materials market.

Assumptions:

• There exist two areas, A and B, each of which has a final market and a source of ra materials;
• Region A has a larger final market than region B;
• There are punctiform raw materials markets;
• The markets of the two regions are entirely separate;
• The unit costs of production are the same in the two regions;
• Unit costs of transportation are constant: total transportation costs are proportional to distance and are the same in the two regions.

There are two scenarios:

I. City A and city B; there’s the market M

In B we have a smaller city and an higher transportation cost.

In A we have a larger city and a lower distance from the market of raw material.

So the firm “z” certainly choose to locate in city A.

II. City A > City B

City A > distance from market.

Z still decide to locate in city A, because the city is bigger.

This decision apparently look irrational, but the larger market compensate the larger distance that the farm has to cover the size of the market justifies this seemingly irrational choice.

Market area’s model

17th March 2020

Market Area’s Model Supply is punc-form; demand occupies space

Preliminary considerations

If only agglomeration economies existed, the whole production would take place in the same place.

If only transport costs existed companies would distribute themselves desperately in space, with an unskilled production of all the goods produced to meet local demand.

What happens in an intermediate situation where both agglomeration economies and transport costs exist? One way to answer is to analyze how economies of scale (the first form of agglomeration economies) and transport costs combine themselves to define market areas: spatial division of the market between producers, areas where firms can act as if they were in a monopoly position.

Assumptions:

• Demand is distributed uniformly along a linear market;
• Demand is entirely price-inelastic;
• Two firms offer the same product with identical cost functions (an assumption that, as we shall see, the model makes only initially);
• The locations of the two firms are given;
• The cost of transportation per unit of distance is constant and it is paid by the consumer.

Final considerations

• Consumers located closer to the production site obtain an economic advantage in terms of lower transportation costs (when these are assumed to be borne by consumers) and therefore pay a lower overall price for the good, provided the firm does not engage in price discrimination;
• The firm may discriminate on price within its market area, where it operates a monopoly, without losing market shares.

Point where the consumer is indifferent between purchasing from firm A or B, because both charge the same price for the good economies of scale (i.e. lower production), (% %&&'&% )&$''('$ )' 1*"'(1*"'( the threshold separating the two firms’ markets, represented by point b, shifts in position so that THRESHOLD it marks out a larger market area for firm B between the two market areas $ *%$ % The greater the distance from the production site, " the more the purchase price of good increases % # because of the increase in transportation costs ! " $ #! " & # )%*+($,%*(%,-.,/ )%*+($,%*(%,-.,0)%*+($,%*(%,-.,/ )%*+($,%*(%,-.,0

If one of the two firms (e.g. firm B) enjoys economies of scale (i.e. lower production), the threshold separating the two firms’ markets, represented by point b, shifts in position so that it marks out a larger market area for firm B.

Price discrimination

Price discrimination A may decide to lower the price of the good only in the market segment shared with B, so as to expand its market area.

This strategy