From Neighborhoods to Nations: The Economics of Social Interactions

By Yannis M. Ioannides | Go to book overview

CHAPTER 4
Location Decisions of Firms and
Social Interactions

4.1 INTRODUCTION

This chapter aims at understanding location decisions of firms as decisions in the presence of social interactions, thus unifying a number of approaches economists have used in studying such decisions and in measuring patterns of industrial agglomeration. It is a salient fact that firms’ evaluations of alternative locations depend directly on where other firms locate and that this makes these approaches most interesting within a social interactions framework. To assess such direct effects, this chapter uses as a benchmark outcomes where firms compete for scarce land sites that have differential effects on their own profitabilities but no other interactions.

Firms may benefit from proximity to low-cost suppliers of manufactured inputs and resources and from proximity to their customers. Because suppliers and customers may be other firms or workers, location decisions of firms and of individuals are interdependent. Benefits from agglomeration are taken as given by any individual firm, but agglomerations result from an aggregate of actions of all firms. This simultaneity suggests that agglomerations can be studied fruitfully as equilibrium outcomes. For agglomerations to prevail, the benefits must be sufficiently strong to compensate firms for the higher prices that follow from competition for land, the key scarce input to be allocated at sites hosting agglomerations. The configuration of economic forces should be such that alternative location patterns are stable in the presence of shocks. As in chapter 3, I highlight models that allow us to learn the most from empirical investigations.

Of course, beneficial interactions among firms and among firms and individuals in the context of the urban economy are not new concepts. Economists credit Smith (1776) and Marshall (1920) for recognizing that productivity and wages are higher in larger cities. This phenomenon lies at the heart of modern modeling of the urban economy and has been explored empirically in numerous studies. Of the two most influential works in the modern theoretical literature, that by Henderson (1974) explores the consequences of the urban productivity premium for the urban structure of an economy made up of trading cities. The study by Krugman (1991a) offers a framework for

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