Slide #1.

CHAPTER 4 Key Agglomeration Economies ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.
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Slide #2.

• Agglomeration Economies: Introduction • Firms cluster in cities to exploit external economies of scale in production. • The two types of agglomeration economies are: ©McGraw-Hill Education. 1. Localization economies 2. Urbanization economies
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Slide #3.

• Types of Agglomeration Economies • Agglomeration economies generate relatively low production costs for firms that cluster. • The cost advantages of clustering generate large concentrations of employment. • The four types of agglomeration economies are: ©McGraw-Hill Education. 1. Sharing intermediate input producers 2. Tapping a common labor pool 3. Improving skills matching 4. Sharing knowledge
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Slide #4.

– 1. Sharing Intermediate Input Producers The first type of agglomeration economy discusses how some firms cluster around producer of intermediate inputs. • An intermediate input is something produced by one firm and used by a second firm as an input to the production process. • Firms cluster to share the producer of an intermediate input if: – Economies of scale – Face time What are the implications of the two conditions? Let’s discuss. ©McGraw-Hill Education.
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Slide #5.

• Sharing an Intermediate Input: Average Cost of an Intermediate Input ©McGraw-Hill Education.
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• Sharing Intermediate Input Producers: Example • Dressmakers cluster around a button maker (Vernon, 1972). – Face time is required to design and fabricate unique button suitable for a particular dress. – Dressmaking firms are small and nimble. – Scale economies in button production are large relative to demand per dressmaking firm. What other examples can you think of? Let’s discuss. ©McGraw-Hill Education.
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Slide #7.

• 2. Tapping a Common Labor Pool The second type of agglomeration economy discusses how some firms cluster to share a pool of workers to reduce the costs of transferring workers from unsuccessful firms to successful firms. • Market conditions for this type of agglomeration economy are as follows: – Demand per firm varies from one period to the next. – Workers move from declining firms to rising firms. – Total market demand is constant over time. • Clusters facilitate transfer of workers for lower search and relocation cost. ©McGraw-Hill Education.
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• Tapping a Common Labor Pool: Labor Pooling Generates a Lower Wage • For workers mobile between cities, what is required to achieve a Nash equilibrium in workplace choice? • How can we use the concept of certainty equivalent to translate the expected utility of the risky isolated job into dollars? ©McGraw-Hill Education.
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Slide #9.

• 3. Improving Skills Matching The third type of agglomeration economy is related to the matching of workers and jobs. • Workers and firms are not always perfectly matched. Skill mismatches require expensive worker training to better match workers and jobs. • Key assumptions of classic model of labor matching include: – variation in worker skills – economies of scale in production – firm skill requirements – training cost ©McGraw-Hill Education.
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Slide #10.

• Agglomeration Economies: Labor Skills Matching ©McGraw-Hill Education.
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Slide #11.

• 3. Improving Skills Matching (cont.) • The formula below illustrates the agglomeration economies associated with improved matching of workers and firms as a city’s workforce grows. In general, if the number of workers in the city is n, the average skills mismatch (m) is calculated as: m = 1/2 (n ‒ 1) • As n increases, the skills mismatch decreases (m = 1/6 for n = 4 and m = 1/10 for n = 6), decreasing training costs. ©McGraw-Hill Education.
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Slide #12.

• 4. Sharing Knowledge The fourth agglomeration economy involves the benefits of sharing knowledge and promoting innovation. • The sharing of knowledge provides an incentive for firms to cluster as innovation leads to lower costs and higher profit. • Knowledge spillovers could occur within an industry (localization economies), but the spillovers often cross industry boundaries (urbanization economies). What are the key ideas of Alfred Marshall’s classic description of knowledge spillovers? ©McGraw-Hill Education.
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Slide #13.

• Benefits of Urban Size In addition to the four types of agglomeration economies that increase productivity and decrease production cost, three other advantages of city size generate lower wages production cost. • Joint labor supply: better job opportunities for two-earner households • Learning: increase in human capital through learning through imitation • Social interactions: better matching of hobbies and social interests ©McGraw-Hill Education.
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Slide #14.

• Equilibrium Size of a Cluster • Agglomeration economies generate external benefits that provide an incentive for firms to cluster. • The clustering of firms increases total employment, generating agglomeration diseconomies that at least partly offset agglomeration economies. • What would happen if there were an increase in the number of workers in a cluster? • What would be the effects of an increase in population density? ©McGraw-Hill Education.
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Slide #15.

• Equilibrium vs. Efficient Cluster Size Profit and Cluster Size Equilibrium ©McGraw-Hill Education.
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Slide #16.

• Equilibrium vs. Efficient Cluster Size ©McGraw-Hill Education.
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Slide #17.

• Evidence for Agglomeration Economies Research in the last few decades provides evidence that the clustering of firms in cities increases worker productivity, promotes the development of new production facilities, and increases employment. • How does clustering of firms in cities affect the productivity of workers? • How does clustering of firms in cities promote the development of new production facilities? • How does clustering of firms in cities increase employment? ©McGraw-Hill Education.
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Slide #18.

• Economic Impacts of Million-Dollar Plants A study by Greenstone, Hornbeck, & Moretti (2010) explored the effects of a large manufacturing plant on a metropolitan economy. • • What elements does the study focus on? How is worker productivity affected in existing manufacturing plants in the context of agglomeration economies? • How does the location of a million-dollar plant affect wages? ©McGraw-Hill Education.
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Slide #19.

• Knowledge Spillovers • As per research summarized by Carlton and Kerr (2015), knowledge spillovers cause firms to cluster and increase the number of firms (firm births) and total employment. • The studies drew the following additional conclusions: – The largest knowledge spillovers occur in the most innovative industries. – Knowledge spillovers are highly localized. – Knowledge spillovers are more prevalent in industries with small, competitive firms. ©McGraw-Hill Education.
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Slide #20.

• Single Industry Clusters • When external economies in production are confined to firms in a specific industry, these “localization economies” can generate large clusters of firms producing the same product. • In the United States, the most famous industry clusters are: – carpets in Dalton, Georgia (41 percent of national employment in carpets) – costume jewelry in Providence, Rhode Island (55 percent) – elevators in Indianapolis, Indiana (20 percent) – video production in Los Angeles, California (44 percent) ©McGraw-Hill Education.
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• Industry Clusters (1 of 3) Metropolitan Area Seattle, WA 2015 Employment 53,800 Location Quotient 12.3 Software Publishers San Francisco, CA 20,700 3.9 Software publishers San Jose, CA 16,900 6.91 Software Publishers Atlanta, GA 12,300 2.16 Software Publishers Madison, WI 8,900 10.17 Industry Software Publishers ©McGraw-Hill Education. Metropolitan 2015 Location Area Employment Quotient Investment New York, NY 53,888 5.71 banking & securities Investment Chicago, IL 8,381 1.52 banking & securities Investment Bridgeport, 3,782 8.42 banking & CT securities Ship Virginia Beach, 26,232 59.61 building & VA repairing Ship Mobile, AL 5,645 49.15 building & repairing Industry
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• Industry Clusters (2 of 3) Industry Motion Pictures & Video Motion Pictures & Video Motion Pictures & Video Motion Pictures & Video ©McGraw-Hill Education. Metropolitan 2015 Area Employment Los Angeles, CA 106,800 Location Metropolitan 2015 Location Industry Quotient Area Employment Quotient 11.74 Ophthalmic Los Angeles, 2,953 2.82 goods CA New York, NY 35,500 2.48 Ophthamali Rochester, NY c goods 1,924 29.63 New Orleans, LA 2,900 3.33 Ophthamali Dallas, TX c goods 1,837 2.28 Bridgeport, CT 2,300 3.3 Ophthamali Tampa, FL c goods 1,355 6.73
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Slide #23.

• Industry Clusters (3 of 3) Metropolitan Area New York, NY 2015 Employment 3,076 Sound Recording Los Angeles, CA 2,718 4.09 Aerospace products Los Angeles, CA 49,934 2.48 Sound Recording Nashville, TN 1,936 19.23 Aerospace products Dallas, TX 32,121 2.79 Insurance Claims Los Angeles, CA 3,257 1.86 Aerospace products Wichita, KS 28,062 27.52 Insurance Claims Atlanta, GA 2,382 2.43 Aerospace products St. Louis, MO 16,228 3.57 Insurance Claims Las Vegas, NV 1,030 3.04 Aerospace products Industry Sound Recording ©McGraw-Hill Education. Location Industry Quotient 2.94 Aerospace products Metropolitan 2015 Location Area Employment Quotient Seattle, WA 91,424 12.67
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Slide #24.

• Corporate Headquarters and Functional Specialization • Corporations locate their headquarters in cities to exploit agglomeration economies that cross industry boundaries (urbanization economies). • Corporations cluster to share firms that specialize in providing information that is vital to corporate decisions. • Corporations cluster in cities to share firms providing business services. ©McGraw-Hill Education.
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Slide #25.

• Corporate Headquarters and Functional Specialization (cont.) In the last several decades, the specialization of cities has undergone a fundamental shift. • Large cities have become increasingly specialized in managerial functions. • Smaller cities have become more specialized in production. Why did these changes in functional specialization occur? ©McGraw-Hill Education.
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Slide #26.

– Agglomeration and the Product Cycle: The Radio Industry in New York • Agglomeration economies contribute to the development of new products. • A study by Vernon (1972) identifies the radio industry in New York as an example of an industry that benefited from agglomeration economies in its early design and development stage. What are the key takeaways from the study? ©McGraw-Hill Education.
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– Nursery Cities Nursery cities are defined as large diverse cities that provide a nurturing environment for early product design and development. • Diverse cities foster innovation, while specialized cities facilitate efficient production. • Duranton and Puga (2001) provide evidence regarding relocating firms: – French firms: 7/10 relocated from diverse to specialized city – highest frequency of relocation for innovative industries • Industries with “mature” products have less to gain from diversified cities and relocate to reduce production costs. ©McGraw-Hill Education.
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