O Sullivan Parte 3
O Sullivan Parte 3
O Sullivan Parte 3
Urban Economics
FIFTH EDITION
Arthur O'Sullivan
Departme11t of Economics
Lewis & Clark College
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CHA P TER 4
/ n earlier chapters we explained why cities exisl and why sorne cities are so big. In
this chapter, we'll explore the where of cities. To address the where question, we' ll
examine the location decisions of firms. When a firm chooses a particular location
for its produclion facility, the resulling concentration of employment either generates
a new city, or, more often, causes an existing city to grow. Although location theory
is usually cast in terms of where new firms locate, it applies as well to the expansion
of existing firms. The economic conditions that attract new firms to a city also make
it profitable for firms already in the city to expand their operations. In other words,
Jocation theory helps us explain both why cities arise in particu lar locations and why
sorne cities grow more rapidly than others.
Figure 4-1 provides a useful backdrop for our discussion of location decisions
and urban growth. A city will grow if the number of new jobs gained from the birth
of new firms and the expansion of existing firms exceeds the number of old jobs
lost from firm deaths and contractions. The question is whether growing cities have
relatively large job gains, or relatively small job losses. T he clear message from
Figure 4-1 is that cities differ in their job gains, not their job losses. Although most
cities have roughly the same percentage of job losses, growing cities have larger
gains from births and expansions.
The location decisions of firms are based on profit maximization. A firm's po-
tential profit varíes across space far several reasons. First, it is costly to transport
inputs and outputs, and locations with relatively low transport costs will generate
higher profits, ceteris paribus (everything else being equal). Second, sorne inputs
cannot be transported at ali, and locations with inexpensive local (nontransferable)
inputs will generate higher profits, ceteris paribus. Third, sorne firms benefit from
proximity to other firms in the same industry (localization economies) and other
firm s benefit from being in a large diverse city (urbanization economies). Fourth,
the public sector Jevies taxes and provides public goods and services, and Joca-
tions with a relatively efficient public sector will generate highcr profits, ceteris
paribus.
65
66 Part 1 Markct Forces in the Development ofCitics
FI GURE 4-1 Gross Gains and Losses in Employment in Selected Cities, 1984-1986
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So11rce: Table 2.3 in Randall W. Ebcr~~ ancl Joc A. Sione. Wage <md Adj11.i1111e111 in Local Labor Markers
(Kalamazoo. MI : Upjohn h1>1i1u1c. 1992).
A transfer-oriented firm is defined as one for which transportation cost is the dom-
inant factor in the location decision. The firm chooses the location that minimizes
total transport costs, defined as the sum of procurement and distribution costs. Pro-
curement cost is the cost of transporting raw materials from the input source to the
production facility. Distribution cost is the cost of transporting the firm's output from
the production facility to the consumer.
T he classic model of a transfer-oriented firm has fou r assumptions that focus
attention on transportation costs as the dominant location variable.
• Fixed-factor proportions. The firm produces its fixed quantity with fixed
amounts of each input. In other words, the firm uses a single recipe to produce
its good, regardless of the prices of its inputs. There is no factor substitution.
• Fixed prices. The firm is so small that it does not affect the prices of its inputs
or its product.
Under these four assumptions, the firm maximizes its profit by minimizing its
transportation costs. The firm's profit equals total revenue (price times the quantity
of output) less input costs and transport coses. Total revenue is the same at ali
locations because the firm sells a fixed quantity of output ata fixed price. Input costs
are the same ae ali locations because the firm buys a fixed amount of each input
at fixed prices. The only costs that vary across space are procurement costs (the
costs of transporting the firm 's transferable input) and distribution costs (ehe costs
of transporting the firm's output). Therefore, ehe firm will choose the location that
minimizes its total transport costs.
The firm's location choice is determined by the outcome of a tug-of-war. The
firm is pulled toward its input source because the closer to the input source, the lower
the firm's procurement costs. On the other side, the firm is pulled toward the market
because proximity to the market reduces the firm 's distribution costs.
Resource-Oriented Firms
A resource-oriented firm is defined as a firm that has relatively high coses for trans-
porting its input. Table 4-1 shows the transport characeeristics for such a firm. The
firm produces baseball bats, using 10 tons of wood to produce 3 tons of bats. The
firm is involved in a weight-losing activity in the sense that its output is lighter than
its transferable input.
The key factors in the tug-of-w~r are the monetary weights of the firm's input
and output. The monetary weight of the input is equal to the physical weight of
the input ( 1O tons) times the transportation rate ($1 per ton per mile), or $1 O per
mi le. Similarly, the monetary weight ofthe oueput is 3 tons times $2, or $6 per mi le.
T he firm is considered a resource-oriented fi rm because the monetary weight of its
transferable input exceeds the monetary weight of its output. Although the unit cost
of transporting output is higher (because finished bats must be packed carefully,
but logs can be tossed onto a truck), the loss of weight in the production process
generales a lower monetary weight for the output.
Figure 4-2 shows the firm's transportation costs. If we use x as the distance
from the input source (the forest) to the production site (the factory), the firm's
100
80
60
40
20
Market (M)
2 4 6 8 10
x (Distance from forest)
Forcst (F)
Total transpon co~t (thc sum of procurement cost and distribution cost) is minimi zed at the fores1
bccause the monctary wcight of thc input ($JO) excccds the monetary wcight of thc output ($6). Thc
weight-gaining activiry locates at its source of raw materials.
procurement cost is
PC = W¡. (¡.X
that is, the monetary weight of che input (the physical weight w; times the trans-
port cost rate t;) Limes the distance between forest and factory. The slope of the
procurement-cost curve is the monetary weight of the input, so PC rises by $ 1O per
mil e, from zero at the forest to $100 at the market 1O mi les away.
The distribution costs are computed in an analogous way. If XM is the distance
between the forest and the market, the firm 's distribution cost is
DC = W0 • 10 • (xM - x)
that is, the monetary weight of the output (weight w0 times the transport cost rate t0 )
times the distance from the factory to the market. The slope of the distribution-cost
curve is the monetary weight of the output, so as wc move from the forest toward
the market, DC decreases by $6 per mi le, from $60 at the forest ( 1O miles from the
market) to zero at the market.
Total transport cost is the sum of procurement and distribution costs. In Fig-
ure 4- 2, total transport cost is minimized at the forest site at $60. To see why
transpon cost is minimized here, suppose the firm started at the forest site and
then moved one mi le toward the market. Its distribution cost would decrease by $6
(the monetary weight of bats) but its procurement cost would increase by $ 1O (the
Chapter 4 Where Do Firms Locate?
~18L/OTECA r ---
1_ll\f) v'l-1\...:JIL, ,u U._¡. ¡ -.¡I_¡ ._
monetary weight of the wood), so its total transport cost would increases by $4. The
69
firm's total transport cost is minimized at the forest because thc monetary weight
of the input exceeds the monetary weight of the output. The resource-oriented firm
locates near its input source.
The bat firm is resource-oriented because it is a weight-losing activity, using
10 tons of wood to produce only three tons of bats. The cost of transporting wood
is large relative to the cost of transporting the finished output, so the firm saves on
transport costs by locating near the forest. In this case, the tug-of-war is won by the
input source because there is more physical weight on the input side. Here are sorne
other examples of weight-losing firms.
1. Beet-sugar factories locate near sugar-beet farms because one pound of sugar
beets generates only about 2.7 ounces of sugar.
2. Onion dehydrators locate near onion fields because one pound of fresh onions
becomes less than one pound of dried onions.
3. Ore processors locate near mines because they useonly a fraction ofthe materials
extracted from the ground.
Sorne firms are resource oriented because their inputs are relatively expensive
to transport. Considera firm that cans fruit, producing one ton of canned fruit with
roughly a ton of raw fruit. The finn's input is perishable, and must be transported in
refrigerated trucks, while its output can be transported less expensively on regular
trucks. Because the cost of shipping a ton of raw fruit exceeds the cost of shipping a
ton of canned fruit, the monetary weight of the input exceeds the monetary weight
of the output, and the firm will locate near its input sourcc, a fruit farm.
In general, a firm's input will be more expensive to ship if it is more bulky,
perishable, fragile, or hazardous than the output. Hoover (1975) provides some
examples of such activities:
l. Cotton baling. The input (raw cotton) is more bulky than the output (baled
cotton). The cost of shipping a ton of ftuffy cotton exceeds the cost of shipping
a ton of compacted cotton, so the monetary weight of the input is higher and the
resource-oriented cotton baler will locate near the cotton field.
2. Skunk deodorizing. The input (fully armed skunks) is more fragile and haz-
ardous than the output (disarmed skunks). The cost of shipping a ton of armed
skunks exceeds the cost of shipping a ton of disarmed ones, so the skunk de-
odorizer will locate near the skunk farm.
Dakota, Nebraska, and Montana, close to dairy farms. Sawmills and other wood pro-
cessors are concentrated in Arkansas, Montana, and Idaho, close to vast timberlands.
Market-Oriented Firms
A market-oriented firm is defined as a firm that has relatively high costs for trans-
porting its output to the market. Table 4-2 shows the transport characteristics for
such a firm. The bottling firm uses one ton of sugar and three tons of water (a ubiq-
uitous input) to produce four tons of bottled beverages. The firm is involved in a
weight-gaining activity in the sense that its output is heavier than its transferable
input. The monetary weight of the output exceeds the monetary weight of the input,
so this market-oríented firm will locate near its market.
As shown in Figure 4-3, the firm's transport cost is minimízed at the market.
Because the monetary weight ofthe output exceeds the monetary weíght ofthe input,
a one-mile move away from the market íncreases the distribution cost by more than
40
30
20
Procurement cost
2 4 6 8
x (Distance from input source)
Sugar plantation (F)
Total transpon cost (PC + DC) is minimized at the market becau~c the monctary weight of the output
($4) exceeds the monetary weight of the transferablc input ($1 ). Thc weight-gaining activity locatcs
at its market.
Chapter 4 Where Do Firms Locate? 71
1. Ali inputs (labor, dough, toppings) are ubiquitous (available at all locations for
the same price), so input transport costs are zero.
2. The price of pizzas is fixed, and each consumer along the highway demands one
pizza per day.
3. Ann bears the delivery cost, which is $2 per pizza per mile traveled. Each pizza
delivery requires a separare trip.
Ann will pick the location that minimizes her total delivery cost.
Figure 4-4 shows the distribution of consumers along the highway. Distances
are measured from the western end of the highway (point W). There are 2 customers
at point W. 8 customers at point X (one mi le from W), 1 customer at Y (two miles
from W) , and 1O customers at Z (nine miles from W). Because each customer buys
one pizza and the delivcry cost is $2 per pizza per mile, the monetary weight of a
particular location (the sales volurne times the delivery cost per pizza per mile) is
twice the number of consumers at that location.
Using thc principie of median location, Ann will minimize her transport cost at
the median location. Point Y divides the monetary weights into two equal halves,
so it is the median location. For the locations to the west of Y, the monetary
weight is $1 O (equal to $2 for W plus $8 for X); for thc locations to the east,
the monetary weight is $10 (equal to $10 for Z). The median location divides Ann's
customers into two equal halves; she has 1O customers to the east, and JO to the
west.
w X y s z
Distancc from IV o 2 3 9
Number of consumers 2 8 10
Monclary weighl $4 $16 $2 $20
Ann Jocale!> her pizza parlor al poinl Y bccause il i' thc median location: she delivers JO pizzas to
consume1~5 lO the wesl of Y, and JO lO consumers lO the east of Y. A move f'rom Y to S would
dccrease delivcry cosl for the 10 consumers at point Z (savings of $20). bul increase dclivcry costs
for the 11 consumers al points W. X. and Y (increasc in cost of $22). A movc in the opposite
direction would also increasc total transpon costs.
Chapter 4 Whcrc Do Fiml'> Locate? 73
Location~ L
Dcmand 4 4 4 4 17
Thc median location is in the largc city (l). Any movc to the left of point L will increase rravcl CO'>l5
for thc majority of con~umcrs. incrca~ing total transponation costs.
To show that the median location minimizes total transport costs, suppose that
Ann starts at the median location, and then moves to point S, one mi le east of Y. As
she moves to the east. the good news is that she spends less on delivery to point Z:
she saves $2 per trip to Z, saving a total of $10 in eastward dclívery costs. The bad
news is that westward costs íncrease: shc pays $2 more per tríp to points W , X, and
Y; sin ce there are 11 customcrs to the west of S, her wcstward del ívery costs increase
by a total of $22 ($4 for W, $16 for X, and $2 for Y). Since the increase in westward
costs cxceeds the decrease in eastward costs, the move from Y to S increases totaJ
delivery costs. Thc same is true for a movc in the opposite direction; if Ann moves
from Y toward W, her delivery costs will increase.
The median location minimizes total transport costs because it splits pi1.1.a con-
sumers into two equaJ parts. As Ann moves eastward away from Y, shc moves
furthcr away from 11 customers, but moves closer to only 1O customers. Similarly,
a westward movc will cause her to move closer to 1O customers, but furthcr from
11 customers. In general, any move away from the median location will increase
delivery costs for the majority of consumers, so total delivery cost increases. It is
important to note that the distance between the consumers is irrelevant to thc firm's
location choice. For examplc, if the Z consumers were Iocated 100 miles from W
instead of 9 miles from W, the median location would still be point Y. Total delivery
costs would still be minimized (ata higher leve!, of course) at point Y.
The principie of median location provides another explanatíon of why large
cities become larger. Consider a firm that delivers its product to consumers in five
different cities. In Figure 4-5, there is a large city at location L, and four small cities
at localions S 1 , S2, S3, and S4. The firm sells 4 units in each small city. and 17 units
in the large city. The median location is in the large city, even though the largc city is
at the cnd of the line. A one-mile move wcstward from L would dccrease transport
costs by $ 16 (as the firm moved closer to consumers in the small cities), but would
increase transport costs by $17 (as the firm moved away from consumers in the large
city). The lesson from this example is that the concentration of demand in large cities
causes large cities to grow.
Outpul markel
M
Monetary weigh1 =SIO
1npu1 so urce 8
Moneiary weight = S 15
The firm locales i1s sawmill al 1he pon ( P ) because il is the median transpon location. A move
from P toward either A or 8 would increase output transpon cosis by $10 without afTecting
input transpon costs. A move from P toward M would increase input transpon costs by $30
but decrease outpu1 transpon costs by only $10.
Figure 4-6 shows the location options for a sawmill. The firm harvests logs
from locations A and B, processes the logs inlo Jumber, and then sells lhe Jumber in
an overseas market at point M. Highways connect points A and B to the port, and
ships travel from the port to point M. The sawmill is a weight- losing activity: The
monetary weighls of the inputs are $15 for point A and $15 for point B, and the
monetary weight of the output is $ 1O.
Where will the firm locate its sawmill? Although there is no true median location,
the port is the closest to a median location. If the firm starts at the port ( P), it could
move either toward one of its input sources orto its market.
1. Toward input source A. A one-mile move from P toward point A will cause
offsetting changes in the costs of transporting logs from the two input sources:
the cost of logs from A would decrease, but the cost of logs from 8 would
increase. At the same time, the cost of transporting output would increase by
$ 1O. G iven the offsetting changes in input transport costs and the increase in
output costs, the port location is superior to locations between P and A. The
same argument applies for a move from P toward B.
2. To market (M). Unless the firm wants to operate a ftoating sawmill, it would
not move to points between the port and the overseas market at M. It could,
however, move ali the way to the market. A move from P to M would decrease
output transport cost by $ 1O (the monetary weight of output) times the distance
between M and P , and increase input transport cost by $30 (the monetary weight
of the inputs) times the distance. Therefore, the port location is superior to the
market location.
Although the sawmill is a weight-losing activity, it will locate at the port, not at
one of its input sources. The port location is efficient because it provides a central
collection point for the firm 's inputs.
Chapter 4 Where Do Firms Loca1e? 75
There are many examples of port cities that developed as a resuh of the loca-
tion decisions of industrial firms. Seattle started in 1880 as a sawmill town: Firms
harvested trees in western Washington, processed the logs in Seattle sawmills, and
then shipped the wood products to othcr states and countries. Baltimore was the
nation's first boomtown: Flour milis processed wheat from the surrounding agricul-
tura! areas for expon to the West lndies. Buffalo was the midwestern center for flour
milis, providing consumers in eastern cities with flour produced from midwestern
wheat. Wheat was shipped from midwestern states across che Great Lakes to Buffalo,
where it was processed into ftour for shipment, by rail, to cities in the eastern United
States. In contrast with Baltimore, which exported its output (flour) by ship, Buffalo
imported its input (wheat) by sh ip.
ENERGY ORIENTATION
What is the role of energy in the location decisions of firms? ln the first half of the
nineteenth century, energy was a local input, defined as an input that could not be
transported from one location to another. The waterwheel was the first device used
to generate nonanimal mechanical energy. The watcrwheel was turned by waterfalls
and fast-moving streams, providing powcr for production racilities located along
rivers and streams. Textile manufacturers built factories along small backcountry
streams in New England, with waterwheels powering their machinery. Among the
cities that dcveloped as a resu lt of the waterwheel are Lowell, Lawrence, Holyoke,
and Lewiston.
The development ofthe steam engine in the second half ofthe nineteenth century
made energy a transportable input. The steam engine could be operatcd anywhere,
with the only constraint being the availability of coal to fuel the engine. Sorne energy-
intensive manufacturers located near the coal mines in Pennsylvania. Others located
along navigable waterways and shipped coal from the mines to their factories. In
New England, textile firms shifted from backcountry watcrfall sites to sites along
navigable waterways. Production shifted to the Fati River-New Bedford area along
the south coast of New England. The development of the railroad gave coal users
another transport option, causing the development of production si tes along raíl lines.
The development of electricity affected the location patterns of manufacturcrs
Because electricity can be transmitted over distances of severa! hundred miles, a firm
can use the energy generated from water power without locati ng along a backcountry
stream. Similarly, a firrn can use coal resources without shipping the bulky fuel frorn
the mine to its factory. In general, the development of electricity decreased the
irnportance of energy considerations in location decisions.
For so me activities, the availability of cheap energy is sti 11 an important location
factor (Ellison and Glaeser, 1999). Sorne intensive users of electricity (the production
of primary aluminum and chlorine), locate in the Pacific Northwest to exploit cheap
electricity from hydroelectric power. The producers of clay ti les and fertilizer are
intensive users of natural gas, and locate in Arkansas, Louisiana, and Texas, where
natural gas is cheap. The production of cernent and lime requires large amounts
76 Part 1 Market Forces in the Development of Cities
of coal, and firms in these industries locate in Montana, Nevada, and Wyoming to
exploit cheap coal.
How will the deregulation of electricity markets affect the location decisions
of energy-oriented industries? In the regulated market of the I 990s, there was sub-
stantial variation in the price of electricity across states, a result of regulations that
restricted the ftow of electricity across state lines. Deregulation is expected to free
producers to "wheel" power from state to state, and the free ftow of electricity is
expected to reduce the spatial variation in the price of electricity. As a result, fewer
firms will choose locations based on the price of electricity.
What is the role of labor in location choices? On average, labor is responsible for
about three-fourths of the cost of production, so firms' location decisions are sensitive
to the cost of labor and labor productivity. Labor is a local input in the sense that it
is impractical for workers to commute outside metropolitan areas.
50
40
30
20
10
T 2 4 6 8 10
Disiance from market and inpu1s
50
40
T 2 4 6 8 10
Disiance from market and inpu1s
When inputs and ou1pu1s are rclatively heavy and costly 10 transport, thc firrn
minimizes the sum of transport and labor costs by locating close 10 the 111arke1 and
inputs (Panel A. with cost = S~O as shown by point i). A decrease in the physical
weight or unit freight cost caus:s the firm to locate far from the market and inputs.
where labor costs are lower (Panel B. with total cost = $10 as shown by point j).
at point T. In this case, transport costs are high relative to the variation in labor
costs, meaning that the transport-cost curve is relatively steep. As a result, the forces
pulling the finn toward location Tare stronger than the forces pulling the firm toward
locations with lower wages and labor costs, so the tug-of-war is won by Jocation T.
78 Part 1 Markct Forces in the Development ofCitics
In the last several decades, transport costs have become less important in firms'
location decisions. In many industries that have traditionally been resource-oriented
or market-oriented, firms now locate far from their input sources and markets. The
changes in locational orientation resulted from innovations in transportation and
production that have decreased transport costs.
• Transportation technology. The developmcnt of fast ocean ships and con-
tainer technology decreased shipping costs, while improvements in railroads
and trucks lowered the cost of overland travel. Faster and more efficient aircraft
have decreased the cost of afr travel.
• Production technology. Improvements in production techniques decreased the
physical weight of inputs. For example, the amount of coal and ore required to
produce one ton of steel has decreased steadily, a result of improved produc-
tion methods and the use of scrap metal (a local input) instead of iron ore (a
transportable input).
Panel B of Figure 4-7 shows the effects of a decrease in the unit transport costs
and the physical weights of inputs. These changes flauen the transport-cost curve,
shifting the cost-minimizing location to a location 1O miles from the market and
inputs, where labor costs are lower. The decrease in transport costs causes the firm
to switch from transfer orientation to labor orientation.
As unit transport costs and input weights decrease, firrns are more likely to base
their location decisions on access to inexpensive local inputs rather than access to
transportable inputs. A recent example is the movement of the assembly operations
of many U.S. manufacturers to sites along the Mexican border. The steel industry
has moved from the castern United States, with its rich coa! and ore deposits, to
Brazil, Korea, and Mexico- far from both raw materia Is and steel markets. Similarly,
manufacturers have moved from the United States to Asia and Mexico, far from U.S.
markets, because the savings in labor costs are greater than the increase in transport
costs.
equi librium for workers, wages in the South must be lower than wages in the North;
otherwise, there would be an incentive for workers to move to the South, getting
the same wage and better weather as well. In equilibrium, the wage for a given skill
leve] will be lower in the South, and northern workers will be compensatcd for bad
weather by a higher wage.
The lower wage caused by weather will encourage firm s to locate their produc-
tion facil ities in the South. In this case, the local nature of weather and workers'
preference for warm weather makes labor a local input. The firm 's location depends
on the location choice of its workforce: instead of workers following firms. fim1s
follow workers. Graves ( 1979) and Porell ( 1982) provide em pirical support for this
phenomenon. There is evidence that weather has played an important role in location
decisions and urban growth. In the past few decades, the most rapidly growing urban
areas are ones with warm, dry weather (Black and Henderson, 1999; Glacser, Kolko,
and Saiz, 2001 ).
Natural amenities appear to be most important for firms that employ high-
income workers. Since the demands for these amenities are income-clastic, high-
income workcrs are attractcd to locations with amenities, and the firms hiring these
people follow. For example, research and development firms employ engineers and
computer scientists. who place a high value on good weather anda clean cnvironmenl.
One explanation for the shi ft of employment from northern states to the southern and
western states is that rising income has increased the dcmand for natural amenities,
causing workers to move to areas that provide these amenities.
that for the nation as a whole, 25 percent of the metropolitan workers are college
graduates. A dissimilarity index of 12 would indicate that 12 percent of ali graduates
would have to switch cities to ensure that in every city 25 percent of workers would
be college graduates. For a set of 318 metropolitan areas, the dissimilarity index
increased from 10.2 in 1940, to 11.6 in 1970, to 14.9 in 1990. In other words, the
concentration of college graduates in cities is substantial and growing.
The u neven distribution of human capital has important implications for location
decisions and urban growth. As we saw earlier, cities with above-average education
levels will have larger productivity gains, and will attract more firms and thus grow
more rapidly.
it appears that manufacturers are more sensitive than other types of firms to tax
differentials within and between metropolitan areas. This is sensible because manu-
facturers are likely to be oriented toward the national markel and thus have a widcr
range of Iocation options. Second, metropolitan areas with relatively high taxes on
capital (in the form of taxes on business property) tend 10 repel capital-intensive
industries and attract labor-intensive industries.
1. Tax abatement. In sorne cities, new firms are exempt from local property taxes
for a fixed period (e.g., 10 ycars). Sorne cities offer tax abatements to all new
developments, while others offer abatements only to firms that are particularly
sensitive to tax differentials.
2. Industrial bonds. Sorne cities issue tax-free industrial bonds to finance prop-
erty developments. The local government uses the revenue from the bonds to
purchase the land and leases the property to a private firm. Because the interest
income from industrial bonds is not subject to federal taxes, the bond buyer
accepts a relatively low interest rate (e.g., 8 percent instead of 12 percent).
Therefore, the lessee pays less than the markel interest rate on the money bor-
rowed to finance the project. The use of industrial bonds was sharply curtailed
by the Tax Reform Act of 1986.
82 Part 1 Market Forces in the Development ofCities
3. Government loans and loan guarantees. Sorne cities loan rnoney directly
to developers, and others guarantee loans frorn private lenders. In both cases,
developers borrow rnoney ata relatively low interest rate: Either the city charges
an interest rate below the rnarket rate, or the city decreases the risk associated
with a prívate loan, allowing the developer to borrow prívate rnoney ata relatively
low interest rate.
4. Site development. Sorne cities subsidize the provision of land and public ser-
vices for new development. The city purchases a site, clears the land, builds
roads and sewers, and then sells the site to a developer at a fraction of the cost
of acquiring and developing the si te.
This section discusses sorne of the facts on the location choices of firms. We'll look
at case studies of the location decisions of companies in the semiconductor industry,
Japanese and American auto firms, Mexican garment manufacturers, and the carpet
84 Part 1 Market Forces in the Development ofCities
industry. We'Jl also discuss empirical evidence concerning the effects of labor costs
and unions on location decisions.
transportation. Furthermore, these firms tend to pick locations with relatively high
wages, reflecting their willingness to pay higher wages in exchange for higher labor
productivity. Finally, Japanese-affiliated manufacturers tend to locatc in areas with
relatively high concentrations of minority workcrs.
with knowledge and experience in tufting. Support firms located nearby, supplying
dyes, backing, and other intermediate inputs. Sorne of the old fi rms that had produced
woven carpets went out of business because they were underpriced by tufting firms,
while others moved from the Northeast to the Dalton area and switched to the new
technique. By the middle of the l 950s, Dalton was the carpet capital of the nation.
Of the top 20 carpet manufacturers in the United States, 6 are Located in Dalton, and
13 others are located nearby.
would pay low wages and pass on the savings to GM. As shown in Table 4-3, the
variation in labor cost was relatively large. The difference between the lowest-cost
site (Nashville) and the highest-cost site (Kalamazoo) was $85 per car.
The third step was to estimate taxes for the seven possiblc sitcs. Table 4-3
shows the tax cost per car in the absence of special subsidies and exemptions. The
difference between the site with the highest taxes (Marysville) and the site with the
lowest laxes (Lexington) was $63 per car. Nashville was ranked third, with tax costs
per car $12 higher than Lexington.
This case study suggests that in the absencc of special tax treatment, Nashville
had the lowest total cost. The most important factor was the lower labor costs in
Nashville. Although the city had a slight disadvantage to Tcrre Haute in terms of
market access, this disadvantage was more than offset by Nashville's lower labor
costs.
The state ofTennessee offered three types of inducements to GM. The first was a
$30 mili ion highway project that connected the plant with Interstate 65. The second
was a subsidized job-training program for Saturn workers, worth about $4 per car.
The third was a program of property tax subsidies, worth about $30 per car. As
shown by the numbers in Table 4-3, these subsidies would not have been necessary
in the absence of special subsidies from other states. Other states did offer special
subsidies, and Tennessee responded in kind to stay competitive in the bidding for
the plant.
unions decreases business activity, many studies suggested that the negative effects
are rather small.
SUMMARY
l. Comment on the following from the owner of a successful plywood mili: "Firms
don 't use location theory to make location decisions. 1 chose this location for
my plywood mili because it is close to my favorite fishing spot."
2. Depict graphically the effects of the following changes on the bat firm's cost
curves (shown in Figure 4-2). Explain any changes in the optimum location.
a. The cost of shipping bats increases from $ 1 per ton to $4 per ton, while the
cost of shipping wood remains at $1 per ton .
b. The forest at point F burns down, forcing the firm to use wood from point
G which is 1O miles west of point F (20 miles from the market).
c. The firm starts producing bats with wood and cork, using three tons of wood
and two tons of cork to produce three tons of bats. Cork is ubiquitous (avail-
able at ali locations for the same price).
3. Why do breweries typically locate near their markets (far from their input
sources), while wineries typically locate near their input sources (far from their
markets)?
4. The building of wooden ships was a weight-losing activity, as evidenced by the
piles of scrap wood generated by shipbuilders. Yet shipbuilders located in ports,
far from their input sources (inland forests) . Why?
Chapter 4 Where Do Fim1s Locate? 89
S. Considera firrn that delivers video rentals to its customers. The spatial distribu-
tion of customers is as follows: 1O videos are delivered to location W, 1O miles
due west of the city ccnter; 50 videos are delivered to the ci ty center; 25 videos
are delivered to E, 1 mi le due east of the city center; and 45 videos are delivered
to point F, 2 rn!les east of the city center. Production costs are the same at ali
locations.
a. Using a graph, show where the firm should locate. Explain your location
choice.
b. Suppose that point W is in a valley and point F is at the top of a mountain.
Therefore, the unit cost of easterly transport (shipments from west to east)
is twice the unit cost of westerly transport. If production costs are the same
al ali Iocations, where should the firm locate? Explain.
6. Figure 4-4 shows the location choice of Ann 's pizza firm. Discuss the effecls
of the following changes on Ann's location choice.
a. A tripling of the distance between Y and Z (from 7 miles to 21 miles).
b. A tripling of the number of customers at point W. Instead of two customers
at W there are six.
c. Ann stops delivery service, forcing consumers to travel to the pizza parlor.
7. In Figure 4-6, the weight-losing firm is located at point P (the port). If the
monelary weight of location 8 is $27 instead of $15, will the firm still locale at
point P?
8. There is sorne evidence that people have become more sensitive to air pollulion.
In other words, people are willing to pay more for clean air. lf this is true, what
influence will it havc on the location decision of firms?
9. Consider a firm lhat uses one transferable input to produce one output. The
monetary weight of the output is $4, and the monetary weight of the input is $3.
The distance between M (the market) and F (the input source) is 1O miles.
a. Suppose that produclion costs are the same at ali locations. Using a diagram
like the one in Figure 4-2. explain where the firm will locate.
b. Suppose that the cost of land (a local input) increases as one approaches the
market. Specifically, suppose that the cosl of land is zero al F but increases
al a rate of $2 per mi le as the firm approaches M. Depict the location choice
of lhe firm graphically.
10. Chapter 2 discusses the incubator process. When industries mature. they move
from single-activity clu ters to areas with lower land and labor cosls. Explain
this process in terms of changes in the orientation of firms as they mature.
11. Suppose that country L has a plentiful supply of labor (and low wages) but a
relatively Iow supply of raw materials. In contrast, H has a plentiful supply of
raw materials, but a relatively low supply of labor (and high wages). The two
countries are separated by a mountain range that makes travel between the two
counlries prohibitively costly. Suppose that a weight-losing product is initially
produced in H (close to the supply of raw materials). Suppose that a tunnel is
bored through the mountain, decreasing the costs of shipping raw materials and
output between the two countries. Assume that labore rs do not migrate from
one country to the other.
90 Part 1 Market Forces in the Development of Cities
a. How will the tunnel affect the location choices of weight-losing firms?
b. How will the tunnel affect wages in the two countries?
c. How might this analysis be used to explain (1) the shift in manufactur-
ing from the United States to East Asían countries and (2) the narrow-
ing of the wage differential between the United States and East Asian
countries?
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