1. Land Use, Housing and
Government
Lecture #6:
Firm Location, Market Areas and
Market Competition
Samuel R. Staley, Ph.D.
Fall 2011, Florida State University

2. Recall the economist’s view
of cities…
• “Urban economics is designed as the study
of cities. A city, in turn is defined as a spatial
agglomeration of people. Hence, the spatial
location of production and consumption is
inherent in all urban economic analysis.”
William T. Bogart, The Economics of Cities
and Suburbs, p. 39.
• The economics of cities is the economics of
space and spatial relationships in an
economic context
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and Government

3. Where
should a
business
locate
within a
region?
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4. Why Do Businesses Cluster?
• Economies of scale are not spatial
 They are internal to the firm (no other firms benefit)
• Agglomeration economies: Efficiencies and
increases in productivity that result from clustering
activity in a certain area (proximity).
 Urbanization economies: Efficiencies and increases and
productivity that result from density, or being in a city.
 Localization economies: Efficiencies and increases and
productivity that result from locating near other related
firms.
• Agglomeration economies are external
 Firms cluster
• Transportation costs are critical factors
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5. Location is Driven by the
Firm’s Production Function
• Natural resources
 Weight “losing” firms locate near resource
base
• Production, manufacturing & assembly
 Transportation costs for assembly &
production
 Logistics
• Labor
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6. Why Do Firms Locate Where
They Do?
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7. Dr. Staley, Fall 2012 ECP3617: Housing, Land Use 7
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8. Firms Compete for Land
Key is Rent Gradient Hierarchy of Place
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9. What Happens When
Firms Decentralize?
• Commuting costs still
determine location
• Now, wage rates reflect
differences in commuting to
CBD vs. a firm located closer
to the edge
• Firms are no longer
homogenous
• Add a wage gradient to the
land gradient
• Firms now compete for
workers between the
locations
• NOTE: workers bid up land
closer to their employment
based on compensating
differentials in commuting vs.
wage rates.
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and Government

10. The Fully Decentralized City
• Decentralized firms
have important
advantages over
centralized firms
• They can offer lower
wages (and lower
their cost of
production)
• They can better
match the labor force
to needs
• They minimize
commuting costs
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and Government

11. Dr. Staley, Fall 2012 ECP3617: Housing, Land Use 11
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12. Share of Employment
in US Urbanized Areas
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13. Changes in US Urban Areas
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14. Change in US Urban Densities
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15. Market Areas and Urban
Hierarchy
• Conventional economics:
 price (P)
 quantity (Q)
 Qd = A + b(P)
• Now, add a distance term
 Quantified by looking at transportation
costs (dr)
 Now Qd = A + b(P + dr)
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16. Effects of Transportation Costs
on the Demand Curve
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17. Further Analysis:
Price, Cost & Distance
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18. Dr. Staley, Fall 2012 ECP3617: Housing, Land Use 18
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19. • Derive the
distance demand
curve
• Translate
conventional price
quantity
relationships
• Derive quantity-
distance
relationship
• If price changes,
demand curve
shifts
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and Government

20. Multiple Firms, Multiple Market
Areas
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and Government

21. Making
Demand
3-D:
The
Demand
Cone
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and Government

22. Examples of market areas
Product/Service Radius (miles)
Soft drinks (soda) 68
Concrete production 144
Ice cream 158
Bolts, nuts, screws 167
Fertilizers 828
Cigarettes 1,108
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23. Economic Function Minimum Population
General merchandise 6,859
Restaurant 460
Candy store 35,000
Health care service 637
General grocery store 2,570
Dentist 426
Drug Store 458
Bank 616
Hospital 1,159
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24. What will increase the size of a
market area?
• Fixed costs increase
 requiring higher prices to be competitive
• Costs per trip fall
 Allowing customers to travel farther
• Frequency of trips fall
• Density falls
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and Government

25. Other factors that could influence
the size of a market area over time:
• Inflation
• Changes in technology (e.g., big box
retailing)
• Development of other cities & locations
• Propensity for industry clustering
• Interdependencies among people and
businesses
• Location specific attributes
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and Government

26. Optimal output for the
Individual Firm
• Profit maximizing
firm
 MR = MC
 Economic profits
>0
• Output < market
optimum
• Price > market
optimum
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and Government

27. The ability to maximize profits will
determine the size of the market area
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28. Market areas will expand until
competition limits further growth
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29. • Monopolistic
competition
 Free entry and exit
 Homogeneous
product
• Allows normal
profits
 Economic profits =
0
• Optimum output
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30. In a perfect market, all areas would
be served
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31. The size of market areas will be
determined by competition
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32. Determining the Size of
Market Areas
• Basic Parameters
 v: frequency of trips (consumption)
 k: trip cost per mile
 mc: marginal cost of goods to retailers
 C: fixed cost for retail facility
 F: Buyer density
• Key Variables
 P: unit price of a good
 D: distance between retail stores
 T: market area boundary
 S: individual store sales
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33. Market Area Boundary
• P + kT = P0 + k(D-T), or
 P + kT = P0 + kD – kT
 P + 2kT = P0 + kD
 2kT = P0 – P + kD
 T = (P0 – P + kD)/2k
• Thus,
↑k≈↓T
↑D≈↑T
 ↑ P0 or ↑ P ≈ ↑ECP3617: Housing, Land Use
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34. Annual sales per store…
• Depends on frequency trips and
density of buyers, so S = 2TvF, or
• S = vF[(P0 – P + kD)/k]
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35. Entry and Store Density
• Long-run Equilibrium:
 D = [(C/kvF)1/2;
 P = mc + (kC/vF)1/2;
• Thus, goods purchased more frequently (↑v)
increases store density (↓D) and lowers profit
margins (↓P) (neighborhood pharmacy).
• Higher fixed costs will lower store density
(↑D) and increase profit margins (↑P) (mall
stores)
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and Government

36. Real World Retail
• On-line retailing
 Amazon.com
 Ipad
 Dell Computer
• Life-style centers
 Spending patterns
 Income
 Versus strip shopping centers
 Versus conventional shopping malls
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37. Market Areas and Agglomeration
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38. Hierarchy of
Place
• Some cities serve
larger markets
than others
• Primary services
• Secondary &
tertiary services
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and Government

39. From:
John P.
Blair, Local
Economic
Development
, p. 76
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and Government

40. Dr. Staley, Fall 2012 ECP3617: Housing, Land Use 40
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41. Rank Size Rule
• A cities rank in the urban hierarchy may be related
consistently to population
 Second rank city is 0.5 * population of largest city
 Third city is 1/3 size of the largest city
• Formula: Rank = C/Nb
 C = constant
 N = population
 B = estimated from data on rank & population where b = 1 if the
rank size rule holds
• Study of 29 cities
 Two-thirds, 0.80 < b < 1.20
 Median = 1.09, slightly higher than the rank size rule implies
• Studies using economic definitions estimate b = 1.02
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and Government