Location Theory Research Paper

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1. The ‘Where’ Question: Space is Crucial

Location theory is concerned with the intriguing question where economic activity can be found. It addresses the geographic dimension of economic decision and analyses both the behavior of firms and of households. Thus the locus, the geographic place, is of prime interest in location analysis.

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More specifically, the main question in location theory is: which are the motives to choose a particular location and which are the geographic implications? And clearly, there is not a single, conclusive answer. A student who has just left the university will usually have different aims in mind when seeking for a residence than his parents who have just retired. But despite variety in motives and goals, there are many things which are common to anyone seeking a residential location (such as affordability, accessibility, quality of life, etc.).

The same applies to business firms. An ice-cream vendor will not open a shop in a dead-end street, and a diamond seller will not opt for a location in an underground station. Both may have profit motives, but their decisions where to locate may be totally different. But also here, if one observes the actual location patterns of business firms, there are some similarities. The location of households and firms does not exhibit a random pattern worldwide, but displays many regularities. For instance, all over the world we find a population concentration and business concentration in river basin areas and delta areas, a phenomenon already observed by Adam Smith more than 200 years ago.

Location theory does not only investigate the spatial point decision of an individual actor (household, business firm), but looks also into the regularities (patterns, geographic structures) that emerge out of the decision of individual actors. Locational decisions are usually influenced by so-called externalities, which means that the decisions made previously by a group of actors impact on the current decisions of new market entrants. This explains why cities emerge as a spatial conglomerate of many individual actors seeking urbanization economies, or why industrial complexes arise as a consequence of agglomeration advantages (such as a joint use of infrastructure). Thus, location theory does not only have a micro aspect, but also a macro (collective or social) aspect; locational decisions are at the end usually interactive decisions.

Clearly, once a spatial pattern of economic activity has been realized, it will influence other patterns as well. Consumers tend to be attracted by the proximity of shopping facilities, business centers tend to orient themselves towards the presence of a critical mass of clients with a high purchasing power, etc. Thus, there is interactivity in location at both the micro and the meso macro scales.

The next section offers a very concise presentation of some highlights from traditional location theory, followed by an exposition of some modern developments. After a discussion of firms’ location decisions, households’ decisions will be looked at. The impact of the modern network economy and of information and communication technology (ICT) will be dealt with as well. The paper will be concluded with some prospective remarks.

2. Con entional Wisdom on Location Decisions of Firms

Location theory forms a central element in regional economics and economic geography. Location and trade were already regarded by the grandfather of economics, Adam Smith, as two interwoven phenomena: location impacts on trade flows and trade impacts on location decisions.

In the history of economics a great variety of contributions on the nature, motives, and implications of the location of production can be found. We will offer only a few examples here from this rich history.

The location and land use in agricultural production was studied extensively by Von Thunen (1842), by using a simple profit maximization scheme for spatial product choices, as a function of revenues, product types, and transport costs. He was able to demonstrate the existence of a set of concentric rings of agricultural products, based on Ricardian comparative cost theory leading to product specialization. Von Thunen’s rent theory has formed the basis for the urban land rent theory, which has become a central focus in urban economics.

The location of industrial firms was investigated by Weber (1909) by looking for a cost minimizing location solution of a new firm on the basis of resource inputs (and other material inputs) and product outputs (to be shipped to the market). This intriguing and complex question was solved by Weber (1909) by using a triangular force field of input and output points, within which the optimal location has to be found.

The spatial concentration of economic activity in a city has also been studied intensively, starting from the work of Marshall (1925), who argued that agglomeration benefits are central for city formation. He referred to externalities which caused such benefits, in particular better information and skills, trade growth, specialized equipment, and availability of skilled labor.

The shift towards multiproduct economies and the spatial inter-relationships between multiple products received due attention some 50 years ago in the context of the so-called central place theory, developed by Christaller (1933) and Losch (1954). The basic idea is that the location of economic activity is subject to agglomeration advantages. As a consequence, economic activities are not spread randomly, but manifest themselves in clusters. Moreover, in the light of product diversity, price elasticity, and the existence of daily and non-daily goods, a spatial hierarchy is a logical outcome of a series of profit-maximizing location decisions of firms. This hierarchy means that a place with a certain ranking order also includes firms producing goods with a lower order. This theory has become a landmark in location theory and has had farreaching implications for spatial planning.

In the postwar period, a wide range of new and refreshing contributions has also been offered, such as the growth pole theory, the cumulative causation model, and the forward–backward linkage view on regional development.

The complexity of location decisions in a continuous space or in a discrete network configuration has also prompted a rich research field in the operations research discipline, where many attempts have been made to derive mathematically the optimal site of public facilities or private goods, especially in the context of a multiproduct location decision. It should be noted that in a discrete space with a finite number of location options the number of combinatorial possibilities may be formidable, so that rather advanced mathematical software has to be developed.

In the 1990s much attention was given to a rigorous analysis of the link between trade and locations, especially in the spirit of the monopolistic competition approach advocated by Krugman (1991). In this analysis, spatial accessibility does not only favor transport and trade, but geographical clustering is also positively influenced by a strong critical mass of local demand, by increasing returns to scale in the production sector and by a good transportation system in the area. This will be discussed in more detail in Sect. 3.

3. Location and Growth

Locational decisions are usually not stand-alone choices of a firm, but are part of a broader set of firm decisions, e.g., on market areas, marketing channels, technology to be used, image, etc. Against this background transport—and thus trade—plays an important role. This fact was already recognized in the well-known Hecksher–Ohlin theory on international (or interregional) trade flows, where trade intensity between two countries is dependent on the comparative advantage of the use of factor inputs. Clearly, also the degree of homogeneity of products to be traded plays a role here. Based on the assumptions of monopolistic competition, Dixit and Stiglitz (1977) have tried to make the Hecksher–Ohlin theory more realistic, inter alia by allowing for product differentiation. In this way, both interand intra-industry trade flows and locational patterns can be analyzed. This integration of trade theory and location theory forms one of the main characteristics of modern growth and trade theory.

In this context there is also a need for a more dynamic perspective to spatial equilibrium phenomena. This presupposes a more integrated view on locational decisions and emerging market patterns, thus necessitating an economic growth perspective.

Consequently, trade and location are endogenously determined in modern economic growth theory, as developed inter alia by Krugman (1991). This also means that factor mobility, transportation costs, and transaction costs become an integral part of modern theories on location and urban or regional growth.

In a recent study by Fujita et al. (1999), the authors offer an attempt to re-track economic geography (and regional science), while they also aim to build a ‘new economic geography’ based on a few vigorous economic principles. The authors signal a regrettable dividing line between mainstream economics and the economics of location. They aim to build a bridge on the basis of a few simple (certainly not universally valid) concepts, in particular the imperfect competition model marked by increasing returns to scale (originating from Dixit and Stiglitz 1977). In an open (multiregion or multicountry) system various types of spatial agglomeration patterns may emerge, depending inter alia on transport costs, forward and backward linkages, and immobility of resources. The authors offer a new perspective in their effort to bring general economics closer to regional economics. They illustrate their arguments by referring to coreperiphery phenomena, agriculture, urban systems, city size, transportation, international trade, and industrial clustering. The book forms a clear manifestation of the rigour of solid economic analysis for the explanation of the spatial patterns and evolution of economic activity.

The two pillars of regional economics are certainly formed by agglomeration economies and generalized transportation costs. Much emphasis is made in the book on the economic analysis of urbanization and scale advantages, but less on transportation costs. In our era of ICT development where many economists advocate the ‘death of distance,’ it would have been necessary to pay more attention to both psychological and virtual distance costs, and their implications for the spatial organization of our world (see Sect. 6). It is clear that a further integration of location theory, transportation science, trade theory, and industrial organization seems to be a necessary condition for a rigorous way forward.

4. Where Do People Wish to Li e?

The locational choices of households can be looked at from many perspectives exemplified by a great variety of historical, cultural, social, economic, and geographical views. The most prominent and visible pattern in the spatial distribution of households is the clustering of people in the vicinity of firms that demand workers for their economic activities. For example, the Industrial Revolution, based on new, steam-driven technology, created mass-produced goods at particular geographical locations where the inputs for the industrial production process were found. The workers needed for this new mass production of goods were forced to settle near the factories, given the limited transport facilities at the time and their low financial means.

The ultimate example of spatial clustering of economic agents (firms and households) is observed through city formation and city growth, both in developed (industrialized) countries and in developing countries. Nevertheless, some people do not live in the urbanized areas with the main employment centers, but commute from their home regions to their workplace in the city. This travel distance of households from home to work forms the principal focal point in the classical urban location theories that were developed to explain the spatial structure of agglomerations (see Alonso 1964, Muth 1969, Mills 1972).

The old economic wisdom on urban location decisions of households builds on the functioning of the market for land from which the urban location patterns were derived through the application of standard economic laws of supply and demand. The classical, elementary model for the urban location of households considers the decision-making process of households as a place—utility maximizing process in which a crucial role is played by the travel distance from home to work (commuting distance). For reasons of expositional convenience, company businesses are supposed to be located in the center of the agglomeration (but this was relaxed in later versions of the classical models). In this case, all households would prefer to live in the center, if differences in land prices across the urban space were not yet taken into account (thereby minimizing their commuting costs). However, the excess demand of households for locations in the vicinity of the business center forces the prices for this scarcely available land up, because the households are willing to pay more for central locations. Now, a fundamental locational choice for households emerges in which they have to trade-off the conditions of living near the center (low commuting costs, but high costs for housing) with the countervailing features of living at some further distance of the center (high commuting costs, low housing costs). The difference in the costs for land (housing) will be determined—in the spirit of classical urban models— by an equilibrium state of the land market in which the household’s well-being (or utility) is equalized over all possible locations within the urban space. The main economic principle of bidding for those (urban) locations that households consider to be attractive in some sense remains valid, when differences across households (e.g., size, income, preferences), the existence of urban employment subentries, governmental regulations of land and housing markets, and other locational variations or neighborhood characteristics (public and private facilities, environmental amenities, green areas, socioeconomic composition) are taken into account (see Straszheim 1986). This means that besides valuing shorter distances to the city (employment) center, households bid up housing prices in higher valued neighborhoods.

5. Residential Relocation of Households: Search and Thou Shall Find

People do frequently move to other locations to obtain better housing during the course of their expected lifetime. There are several reasons for this change of residence and most often the motives are job related (labor migrants) or housing related (size and facilities of the dwelling unit). The residential move could, of course, also be due to health, family moves, change in household composition (marriage or living together, childbirth), or improved transport facilities. Shortdistance moves are usually associated with housing related reasons (such as a change in household income), whereas long-distance residential moves are likely to be triggered by job changes (see Clark and Van Lierop 1986). In general, people consider moving when some external shock makes the current location suboptimal, that is, the household becomes dissatisfied with the dwelling itself, the housing environment (social bonds with people living in the neighborhood, availability of parks, recreational facilities, playgrounds and schools), or the employment opportunities that are accessible from the current location through commuting. This shock may originate from the internal household circumstances (e.g., childbirth or a divorce), be related to market forces (rent, interest rate, commuting costs) or be due to externalities such as noise caused by new neighbors or, for example, pollution of the local environment (air, water, soil).

The propensity to move creates a search process in which households try to improve their current situation. At the heart of this search process, households face a lack of information on potential dwellings at alternative locations and are confronted with time and money costs to acquire such information. Moreover, in the search process the household has to decide on the spatial area of search. A residential move will then be made in case the expected gain is higher than the moving costs (this may also include nonmonetary costs related to the psychological value attached to the local social network of contacts).

Accordingly, it is well-known that residential moves are affected predominantly by age which represents the stage in the life cycle. Furthermore, households do not necessarily move in response to small changes in the environment due to transaction (moving) costs. From a methodological point of view, the search behavior of households on the housing market can be investigated appropriately by employing duration modeling techniques in which variations in residential duration are used to analyse housing market dynamics (preferably in a spatial context). Recent theoretical developments along the search-theoretical angle have also stressed the simultaneity of the decision to move and to change jobs, thereby taking into account commuting costs (see Van Ommeren et al. 1996). One of the central recent issues in this respect is also whether people follow jobs (as outlined in the classical urban models) or jobs follow people (as argued in previous sections on industrial location). Empirical research has established evidence that firms tend to follow—but not to lead—workers to suburban areas (see White 1999).

Last but not least, it should be emphasized that in many Western societies the possibilities to realize the demand for particular locations are limited due to regulatory measures on the housing markets and restrictive spatial planning policies. In many western countries, both housing demand and supply are regulated extensively (by means of price regulation, allocation devices by local communities, etc.).

6. Modern Residential Location Behavior in a Network Society: The Death of Distance

Nowadays households live and work in an information society in which economies are characterized by networks and increasingly build on the input of knowledge (and less on the classical production factors capital, labor and land). This new paradigm for the world economy—in which Information and Commutation Technology (ICT) plays a decisive role (see Castells 1996)—has significant consequences for the spatial distribution of activities (at the macro level) and the location decisions of agents (at the individual level). The globalizing world creates footloose agents that are not tied to specific geographical places (either market or input-related), but at the same time localization trends can be noticed with an increasing importance of local locational factors (such as favorable living conditions, the environmental quality of life and housing facilities).

So what are the main effects of ICT on household location and relocation decision-making? First, ICT greatly influences the search process for new dwellings (and alternative locations), since, search costs become virtually zero due to easy and full access to information (e.g., via the use of Internet). It may, however, be difficult to filter adequately information through these new media and also to obtain reliable information. Moreover, the actual moves still remain to be costly due to monetary and nonmonetary (psychological) moving costs. Second, the ICT-revolution, based on rapidly improving information transport, has initiated a process of internationalization and globalization, and the emergence of the service (network) economy. More specifically, technological progress leads to larger communication flows between firms and households in different regions and cities. In addition, the immaterial character of information removes physical barriers for households in their locational preferences.

As a consequence, geographical distance becomes less and less important (due to the use of Internet, e-mail and fax); this seems to be the death of distance because of the enormous decrease in communication costs. At first sight, people may choose to work at any place they prefer, thereby enabling them to live where they want without taking into consideration the transportation (commuting) cost, as was highlighted in the classical view on household location behavior. However, it also appears that local networks of firms are vital to the exchange of so-called tacit knowledge (embodied in people) by means of face-to-face contacts. For example, headquarters of major companies often prefer to be located in large agglomerations with multimodal transport facilities (especially by air). This implies, then, that geographical proximity remains an important factor in the (re-) location decision of particular groups of households. Consequently, the basic trade-off for households between commuting costs and housing costs does not disappear in their locational choice process.

7. Location of Public Facilities

As has been argued in the previous sections on household locations, the proximity of private and public facilities will affect the locational decisions of households. From their perspective, the location of facilities is taken for granted. The suppliers of facilities do also have to consider the geographical location of their services (given the location of potential customers). In the real world, one observes that a wide range of services to local inhabitants is controlled by public authorities either at the local or at a regional national level. The various types of public facilities can be classified as follows (see Johansson and Leonardi 1986).

Travel to facilities: consumers visit services offered such as schools, libraries, concert buildings, parks, hospitals, etc.

Insurance service facilities: consumers are protected against emergencies due to the existence of certain facilities as fire brigades, dikes, police force, army, etc. Delivered from facilities: consumers obtain benefits (or costs) at the place of residence as a result of certain facilities such as broadcasting, pollution from airports, etc.

In case of the first two classes of facilities, consumers travel to the service concerned and the received benefits will be distance-dependent (due to transportation costs). For the third class, it holds that the consumer obtains the services at home.

In general, facilities are considered to be public if the services supplied by the public authorities also have a ‘public good’ nature. In short, consumption of a public facility does not hinder the consumption by other consumers of that same good (in technical terms, this means that public goods are nonexcludable, non-rejectable and allow for joint consumption). Furthermore, the public authorities decide on the particular location of the public facilities. Therefore a major concern in this location decision is given to the distance of consumers to the service at hand. The distance dependence does, however, also imply that the public goods nature is not complete in the sense that some will have easier (cheaper) access to the service than others. To sum up, the authorities first have to select their set of public facilities (that is, they have to estimate the demand for public goods) and next, they have to choose how to locate these facilities, given the spatial distribution of potential consumers. A well-known hypothesis on the allocation of public facilities across space originates from the early work of Tiebout (1956) who postulated that people reveal their preferences for local (municipal) services by ‘voting with their feet.’ By this ‘feet-voting’ behavior, Tiebout meant that households migrate to municipalities that offer the best combinations of preferred services and associated taxes. It also gives municipalities the scope to affect the supply of facilities. As a consequence, local communities can influence the size and composition of their inhabitants (through the in and outmigration of households) as well as their local tax base to finance these facilities. Of course, households will differ in their spatial (‘voting by feet’) reactions to the provision of various types of facilities. For example, young households with children will probably be attracted by places of residence offering educational services, playgrounds, and recreational amenities, whereas older households are more likely to move to places with support and care services and socialcultural amenities. One of the most important implications of the concept of ‘voting by feet’ is that the allocation of goods takes place more efficiently than with majority voting. This conclusion does, however, presuppose that housing search and moving are costless, ideal places can be found for each household, and that local goods do not yield benefits to people living outside the community. This set of conditions is hard to meet in practice.

To conclude, the ultimate challenge to analyse jointly household location and public facility location would require an interactive modeling framework of spatial equilibrium in which household locational choices affect governmental decisions on public facility location and vice versa.

8. Concluding Remarks

Location theory is essentially the heart of economic geography and regional economics, but it is also linked increasingly to industrial organization and trade theory. In particular against the background of the current globalization process, location theory is positioned in a global force field. This force field leads to many rapid responses and behavioral adjustments of business firms, so that stable and robust locations are increasingly replaced by nomadic types of business behavior. The rapidly emerging technological changes (including ICT) encourage location theory to become a battlefield of industrial forces. Clearly, this dynamic evolution has both advantages and disadvantages, and much empirical work would be needed to find out the pros and cons of this dynamic change.

It also ought to be noted that from an economic perspective much attention is given to rational behavior of individual firms or households. In reality, we observe many behavioral responses which are instigated by derived factors, such as neighborhood effects, uncertainty analysis, intra-firm transaction strategies, outsourcing mechanisms, etc. This suggests that also the behavioral basis of location theory certainly needs to be reinforced.


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