1. GEOGRAPHICAL ECONOMICS (SECOND PART) URBAN AND REGIONAL ECONOMICS José-Luis Roig

2. WHAT IS URBAN AND REGIONAL ECONOMICS Urban and regional economics adds geographical space to the economic analysis of utility-maximizing households and profit-maximizing firms. It lies at the intersection of economics and geography. Urban and regional economics recognizes that goods are produced at certain locations, traded at some locations and bought by individuals who live at one location and work at another location. Distance between different economic activities implies costs for transporting goods and moving people. Distance also defines communication and social interactions among consumers and workers.

3. Increasing Urbanization Rates More than half of the World’s population now lives in cities Source: UN World Urbanization Prospects, 2014 Revision, esa.un.org/unpd/wup

4. Urban Concentration in Europe Population density in 2005 by OECD TL3 region

5. Economic Concentration in Europe GDP per km2 in 2005 by OECD TL3 region

6. Employment in the wine industry (SIC 2084) Sectoral concentration explained by natural advantages

7. Employment in the computer software industry (SIC 7371, 7372, 7373, 7375) No natural advantages

8. Employment in the Computer Software Industry (SIC 7371, 7372, 7373, 7375) San Francisco

10. Employment in the Carpet Industry (SIC 2273)

12. Productivity increases with employment density Elasticity around 5%(U.S.),4.5%(Europe) Doubling density increases productivity by 5%(4.5%)

13. Agglomeration economies Firms can benefit from the concentration of other firms (A. Marshall): - Large labour market - Large market of intermediate input suppliers - Knowledge spillovers

14. Strong regional disparities of GDP per capita in EU - Blue Banana - Nordic Countries - Periphery - Large difference within some countries - Spatial contagion (spatial diffusion of development)

15. Accessibility and Transport Cost: The Market Potential M: Population, GDP,… GDP level provides a crude measure of economic size of a region. Some insight into the potential of attraction of new activity Besides its size, one expects the accessibility of a region from others to be another critical determinant of firms’ and workers’ locational decisions The market potential aims to capture the idea that being close to prosperous regions makes a region more attractive because it offers good access to several large markets

16. Strong core-periphery pattern

17. More spatial dispersion. Prosperous states scattered all over the country Regional disparities are much wider within the European Union than in the United States. Less strong core-periphery pattern

18. How to model the spatial economy We must start from at least one of three assumptions: i.Space is heterogeneous as in the neoclassical theory of international trade ii.There are externalities in production and/or consumption iii.Markets are imperfectly competitive

19. Theory of Industrial Location  What leads firms to locate where they do?  Can space confer monopoly power?  How do compete firms in space?

20. Theory of Industrial Location A. Location of the firm and transport costs B. Location and market areas: spatial monopoly C. Location and market areas: spatial competition

21. A. Location of the firm and transport costs The Weber location-production model (fixed coefficients technology) The Moses location-production model (factor substitutability)

22. The Weber Location-Production Model Transfer-oriented firm: transport cost is the dominant factor in the location decision  The firm chooses the location that minimizes total transport costs Two types of cost: - Procurement cost is the cost of transporting raw materials from the input source to the production facility - Distribution cost is the cost of transporting the firm’s output from the production facility to the market

23. Four assumptions: 1.Single transferable output. The firm produces a fixed quantity of a single product, which is transported from the production facility to a market M 2.Single transferable input. The firm may use several inputs, but only one input is transported from an input source, F, to the production facility. All other inputs are ubiquitous. 3.Fixed-factor proportions. The firm produces its fixed quantity with fixed amounts of each input. No factor substitution 4.Fixed prices. The firm is so small that it does not affect the prices of its input or its output  The only cost that varies across space is transport cost  The firm will choose that location that minimizes transport costs

24. Resource-oriented firm. Firm that has relatively high costs for transporting its input. Example: A firm produces baseball bats

26. 7 tons of beets needed for 1 ton of sugar

27. Market-oriented firm. Firm that has relatively high costs for transporting its output to the market Example: Bottling firm of beverages

29. 10 tns. of wheat needed for 100 tns. of beer

30. Transshipment points and port cities

31. Labor markets and location choices

32. Two inputs and one market: the Weber location triangle Example: car manufacturer uses steel and plastic Profit of the firm: Given the assumptions of fixed coefficients of inputs and fixed prices:  Single establishment – profit maximizer – price taker – perfect competition – 2 inputs single output  Critical factors m1 m2 m3; p1 p2 p3; M1 M2 M3; t1 t2 t3; K  Maximise profit by minimising total costs

33. The Moses location-production model - Now the firm can substitute in favour of the cheaper inputs - The distance from the factory to the market, d 3, is fixed - The firm chooses a location along the arc IJ

34. Budget constraints at the end points I and J

35. The envelope budget constraint

36. Location-production optimum

37. Effect of a road-building program that takes place in the area around M 1

38. B. Location and market areas: Spatial monopoly Spatial market areas: linear market with equal transport rates Space can confer monopoly power on firms The lower transport and production costs are, the larger the monopoly area

39. Spatial market areas: linear markets with different transport rates and production costs

40. C. Location and market areas: spatial competition The Hotelling location game Assumptions 1.Costless firm movement 2. Homogenous product 3. Consumers equally spaced along main street (i.e., sales are a + function of the market area) 4. Perfectly inelastic demand 5. Identical costs and transport rates

41. Welfare implications of the Hotelling result Gain Loss

42. Effect of price competition on the Hotelling result

43. A firm lowers its price assuming that its rival’s prices will not change. Rival firm lowers its price assuming that the original firm will not change its price again. Etc. Every firm is surprised when the other firm retaliates. Result: Price shading continues until the firms price at or (temporarily) below MC

44. Figueiredo et al (2002) (Case of Portugal) Preference for the “home base” (“home bias”) Reasons: - Personal factors - Tangible, non-transferable assets - Social capital (networks of institutions and relationships cannot be replicated outside de home base) Data on firms can identify entrepreneurs’ “prior locality of economic activity”

45. Spatial distribution of new manufacturing Plants created in the investor’s “prior locality of economic activity” Spatial distribution of new manufacturing plants created outside the investor’s “prior locality of economic activity”

47. Investor I weighs in all the regional characteristics of the available spatial choice set and selects the one that will potentially give him the highest profit: Linear combination of characteristics of the area

48. An additional variable is included that allows the investor to value differently the potential profit associated with each choice Region coinciding with the investor’s prior locality of economic activity If there are lower costs (and higher profits) associated with the prior Locality of economic activity of the investor

49. Alternatively: The investor values differently the impact of relevant factors in accordance with the local/non-local nature of the choice Those factors that affect potential profit by reducing information costs are not as significant when the choice under consideration is the investor’s home base For other locations, the investor will have higher information costs and thus may value agglomeration economies and proximity to core regions where more and better quality information is available Effect of the localization in the prior locality of economic activity on each characteristic:

50. Decisions made by 1246 start-ups between 1995 y 1997 Information on the owner situation between 1992 y 1996 Where the current owner (entrepreneur) when worked before the creation of the new firm Spatial unit: “concelhos” (275 with an average area of 322.5 km 2 )

52. A STRUCTURAL MODEL: DIXIT-STIGLITZ-KRUGMAN Accessibility to markets and firm’s profit: a framework for the empirical analysis mill priceiceberg transport cost marginal cost elasticity of substitution/price elasticityquantity sold by the firm in s In the short-term with a given number of firms:

53. Total profits of r over all markets where is the Real Market Potential freeness of trade recall

54. Market potential and factors attraction (Head y Mayer, 2004) Location decision of firms between two locations i and j depends on → Carlton (1983) logit model Hypothesis: firms locate where markets accessibility is highest Sample de 452 Japanese branch plants localized in 57 regions from 9 EU countries in the period 1984-1995

56. Variable costs: wagesprice of other inputs (land, intermediates) Total factor productivity

57. Construction of the market potential: Problem: we do not have data ofand We need to proxy these two variables: we will do it with trade flows Trade flows estimated with a gravity equation:

58. Supply capacity of export country Market capacity of the import country Distance, border effect, same language National production minus exports

59. Regions from different countries Regions from the same country Intra-regional trade Share of GDP of s on national GDP of country S Potential built for 18 sectors (2 digits) each year

60. Production costs: 1. Labor costs observable (payroll sector /number of employees in the region) additionally: non labor costs (only vary across countries) Unemployment rate 2. Other costs non observable a. Capital cost affected by subsidies/taxes: - Corporate tax rate (only vary across countries) - Elegibility to benefit from Structural Funds (Objective 1) b. Control for land supply and price: - Area of the region

61. Evidence on clusters. 3 types: - Number of establishments in the two-digit industry region - Number of Japanese affiliates in the three-digit industry region - Number of affiliates owned by the same Japanese parent or members of same vertical keiretsu Possible efects of these clusters: - Lowering intermediates prices regional production networks - Share knowledge (non observable) - Clusters will form around the same exogenous sources of low input costs or high productivity Hypothesis: clusters form in areas with high market potential in the relevant industry The hypothesis would receive support if after controlling for market potential, the presence of same industry firms lowers the attractiveness of a region

63. Main results: Ambiguous with respect to RMP: - of RMP increases the probability of locating in the region in 3%-11% - “theory doesn’t pay” - Agglomeration variables the most important but, omitted variables?