Chapter 3: Big and Small Cities

One of the purpose of this chapter is to provide some insight into why cities vary in size and scope, addressing the question Why aren’t all cities the same size?

LOCALIZATION ECONOMIES AND INDUSTRY CLUSTER

The clusteering is puzzling because dispersing into separate territories would reduce competition for worker and perhaps brings firms closer to their dispersed costumers. There are some subtle benefits from clustering: sharing the suppliers of intermediate inputs, sharing a pool of labor, and sharing information. The label these external economies is “localization economies” indicating that the cost savings occur only for local firms

Sharing Input Supplier

Some industry clusters occur because firms in a particular industry buy an intermediate input from the same supplier. Firms will cluster around a common input supplier if two condition are satisfied:

1.      The input demand of an individual firms is not large enough to exploit the scale economies in the production of the intermediate input.

2.      Tansportation cost are relatively high. Similiarly, if the intermediate input is bulky, fragile, or must be delivered quickly, proximity is important.

There is evidence of clustering based on input sharing. If a firm face  uncertain and rapidly chaning demand for its product, it will be small and agile, and will have an incentive to share input supplier.

Sharing a Labor pool: varying Demand for Labor

A firm faces two sorts of questions about its future labor demand:

1.      How many workers will we hire?

2.      What sort of labor skill will we need in our workers?

If a firm is uncertain about the quantity of workers it will hire or the skills of its workforce, it will have an incentive to cluster around other firms and draw from a common labor pool. Eventually, the workers in the unsuccessful firms will move to the succcessful one. Worker also can easily switch to a different firm in the city

Benefits and Costs of Labor pooling

Consider a software firm that has two equally likely outcomes in a particular year: good times or bad times. In good times the price of its product is high, so the firm has a relatively high demand for labor. In bad times the price of its product is low, so the firm has a relatively low demand for labor.

Consider the trade-offs associated with moving the firm from the isolated site to the industry cluster with the labor pool, the benefits of moving to the cluster is that during good times, the firm would pay a lower wage and earn more profit.

Sharing a Labor pool: Matching

Consider next issue of uncertainty about what sort of job skills a firm will require. Although a firm probably knows what sorts of labor skills it needs this year uncertainty about the future demand for its product and future production technology causes uncertainty about the firms future needs for labor skills. A large labor pool near an industry cluster provides a wider variety of skills for firms to tap.

Sharing information: knowledge spillovers

A city provides opportunities for intyeractions among people with common interest and thus promotes creative thought. There is evidence that knowledge spillovers encourage industry clustering . knowledge spillovers increase number of new plants births, with the largest effect on industries that employ college. knowledge spillovers are strongest in industries with many small, competitive firms.

URBANIZATION ECONOMIES

Urbanization economies differ from localization economies in two ways. First, urbanization economies result from the scale of the entire urban economy. Second, urbanization economies generate benefits from firms throught the city. They are similar to localization economies in the sense that they arise for the same reasons

1.      Intermediate inputs. Firms from different industries share the suppliers of intermediate inputs, allowing the realization of scale economies in the provision of business services.

2.      Labor pooling.  If  fluctuations in the labor demands of different industries are not correlated, workers in a declining industry can easily switch to a growing industry

3.      Sharing information. The knowledge spillovers lead to innovation in product design and production methods.

EVIDENCE OF EXTERNAL ECONOMIES

In searching for evidence of localization economies, researchers focus on the effects of industry concentration on (1) worker productivity, (2) the number of new production plants, (3) growth in industry employment.

Evidence of Localization Economies

Localization economies as the elasticity of output per worker with respect to industry output, defined as percentage change in output per worker divided by the precentage change in industry output. Agglomeration effects in the office sector  are much more powerfull than those in manufacturing. In addition, the agglomeration effects are largest in the area of the city where the increase in office employment occurs. The benefits associated with localization economies fall rapidly with distance.

The Incubation Process

Localization and urbanization economies are responsible for the incubation process. Product cycle theory of industrial location: product are developed by small firms in areas that allow sharing of inputs and knowledge spillover. When the product becomes standardized, the firm can produce it on a larger scale in its own production facilities.

DIFFERENCES IN CITY SIZE

In this chapter, we’ve seen why some types of firms cluster in cities

Localization Economies

Industries vari in the strength of their localization economies. Some industries experience subtantial cost savings from input sharing, labor poolong and information spillovers, while others experience relatively small cost savings. The stronger the localization economies, the greater the incentive for firms to form an industry cluster with large concentration of employment.

Urbanization Economies

Consider next the role of urbanization economies, the spillover benefits that result from the scale of the entire metropolitan area not just a particular industry. Firms in an industry subject to urbanization economies are attracted to large metropolitan areas and this tend to make large cities larger.

The Role of Consumer Goods

in fact, workers in a city spend some of their income on consumer product provided within the city. The jobs supported by local consumer spending is often labeled local employment. Some product are available in all cities, large, medium, and small. If product has large per capita demand relative to scale economies in production, even a small city will generate enough demand to support a firm producing the product.

AGGLOMERATION ECONOMIES IN MARKETING: SHOPPING EXTERNALITIES

A shopping externalities occurs if the sales of one store are affected by the location of other stores. These shopping externalities cause firms selling related product to form retail clusters. Some retail cluster cause the development of market cities. Other clusters within large cities, generating downtown shopping areas, malls, and shoping centers. There are two types of product that generate shopping externalities: imperfect substitutes and complement.

Imperfect Substitutes

Two goods are imperfect substitutes if they are similar but not identical. For these goods, the clustering of firm selling similar product decrease shopping cost and attracts potential buyers. Some retailers cluster in the city center, while others cluster  in shopping centers and malls.

Complementary Goods

Complementary goods are often purchased on the same shopping trip. The shoe store will benefit from the presence of the pants store because together they provide one stop shopping for consumers. Because of the benefit of one stop shopping, firms selling complementary goods cluster in shopping centers.

INNOVATIONS IN TELECOMUNICATIONS AND THE FUTURE OF CITIES

An improvement in telecomunications has two effects on the number of face to face contacts

·         In a given relationship, some face to face encounters will be replaced by telecomunication: An investment banker could e-mail a client instead of meeting her for a brief conversation; the banker could fax a contract instead of delivering it by hand

·         Easier communication may increase the number of relationships. An investment banker could consult with more people in the process of evaluating the merits of particular project; the banker could handle more projects.

Innovations in telecommunication technology will not cause cities to didappear because some activities require face time, so there will always be a need for cities and the physical proximity they provide.

A shopping externality occurs if the sales of a perticular store oncrease as other retailer move closer to the store. These agglomerative economies in marketing cause the clustering of retailers.