Increasing Returns and Economic Geography

Abstract

Economic geography (the study of the location of factors of production in space) plays a small role in economic modeling, but facts of economic modeling are an intuitively striking feature of real-world economies. The paper intends to show how models and techniques derived from theoretical industrial organization allow a reconsideration of the insights possible from economic geography. To show the application, the paper considers one of the key questions -- why and when manufacturing is concentrated in a few regions. To realize economies of scale while minimizing transportation costs, manufacturing firms tend to locate in regions with larger demand, but location of demand depends on the distribution of manufacturing. The externalities that lead to emergence of the core-periphery pattern are pecuniary (due to supply or demand) rather than primarily technological spillovers. Concentration of manufacturing need not always happen and may depend on a few key parameters. Once population starts to concentrate and regions to diverge, the process will feed upon itself. A model of geographical concentration of manufacturing, based on the interaction of economies of scale with transportation costs, is developed to explain how countries endogenously become differentiated into an industrialized core and agricultural periphery. The model has two regions, and two kinds of production, manufacturing and agriculture, in each region. Also considered in the model are transportation costs, firm behavior, economies of scale, and conditions for manufacturing concentration. The concepts of short-run and full equilibrium are also introduced. The model shows that in an economy with high transportation costs, a small portion of footloose manufacturing, or weak economies of scale, the distribution of the primary strata of peasants will determine the distribution of manufacturing production. When opposite conditions prevail, circular causation sets in, and manufacturing concentrates in the region that gets a head start. (TNM)

Keywords: Economic geography, Economies of scale, Transportation costs, Supply & demand, Location factors, Manufacturing industries, Agriculture industry, Geography, Economic models, Regional analysis, Regional differences, Manufacturing clusters