Cities grow large because of agglomerative economies—benefits firms gain by clustering
together. When firms are located close to each other, production costs decrease, creating a
positive externality: one firm’s activity lowers the costs for others.
There are two types of agglomerative economies:
1. Localization Economies: Firms in the same industry cluster to reduce costs by sharing
resources like labor, suppliers, or knowledge.
2. Urbanization Economies: Firms from different industries cluster in cities, benefiting
from shared infrastructure, services, and a large labor pool.
This explains why most cities grow beyond a single factory to become large industrial centers
Localization economies occur if the production costs of firms in a particular industry decrease as
the total output of the industry increases. Localization economies occur when firms in the same
industry cluster together to reduce production costs, benefiting from shared resources, suppliers,
and a common labor pool. Localization economies
occur for three principal reasons: scale economies in the production of intermediate
inputs, labor-market pooling, and knowledge spillovers.
scale economies in the production of intermediate
inputs
Firms cluster near a common supplier when:
1. A single firm can't produce enough demand to lower costs on its own.
2. High transportation costs make it better to be close to the supplier, especially if the input
is bulky, fragile, or needs quick delivery.
labor-market pooling Clusters make it easier for workers to move between companies, improving
the labor market. In industries like computers, where products quickly change:
1. Job information spreads easily through informal channels, like casual talks, reducing
search costs for workers.
2. Firms are close by, so workers can switch jobs without much cost.
This helps companies fill positions faster and adjust to changes in demand.
Labor-market pooling refers to the benefits of having many companies in the same industry close
to each other, allowing them to share workers more easily. Here's a simple breakdown:
1. Isolated Firm (Panel A): A single firm pays different wages depending on whether it's a
good or bad time. In good times, it hires more workers at higher wages, and in bad times,
it hires fewer workers at lower wages.
2. Firm in a Cluster (Panel B): When many firms in the same industry are close to each
other, they can share workers. Even though wages stay the same ($20) in both good and
bad times, the firm in a cluster can hire more workers in good times (160 workers) and
fewer in bad times (80 workers), which helps balance the demand for labor.
Benefits of Clustering:
Lower Wages in Good Times: Firms in clusters pay lower wages compared to isolated
firms during good times.
More Workers: In good times, firms can hire more workers without increasing wages.
Better Efficiency: Firms can quickly find and hire workers due to the availability of a
large pool of workers in the cluster.
Costs of Clustering:
Higher Wages in Bad Times: Firms in clusters pay higher wages during bad times
compared to isolated firms.
Fewer Workers in Bad Times: During tough economic times, firms hire fewer workers
in the cluster.
Conclusion:
The benefits of clustering (more workers and lower wages in good times) outweigh the costs
(higher wages and fewer workers in bad times). So, clustering helps companies in an industry by
making it easier to find workers and adjust to economic changes.
knowledge spillovers Clusters help workers share ideas and technology quickly. In a cluster,
workers from different companies talk about new products and methods, both at work and during
breaks. The more workers there are, the more ideas get exchanged, speeding up innovation.
