Regional Economics

George Horvth
Department of Environmental
Economics
george@eik.bme.hu
The origins of Regional
Economics
Spatial development and settlement theory
did not form part of early Political Economy
Early economic theory focused on a one-
point economy
Most significant problems were value,
distribution issues and taxation
First efforts in regional economics were taken
by economically trained industrialists,
agriculturalists and transport professionals
They encountered the rules and decision-
making problems of regional economics
during their professional work
This original interdisciplinarity is still present
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Formulating regional economic
theory
Formulation of Economic Theory follows a
historical logic:
1. First: agricultural issues, second: locating industry,
third: locating all other sectors. Transportation as
the means of bridging distances has also been
treated in regional economics from the early days.
2. Regional economics first dealt with locating
individual businesses, i.e.: microeconomic
approach. Only later did it start focusing on
locating several businesses, i.e.: macroeconomic
approach.
3. Regional economics treated competitive scenarios
first, later it dealt with monopolistic situations too,
eventually dealing with the problem of
externalities.
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Properties of spatiality and its
relationship to spatial
development
Aspects of the spatial dimension
Spatial and

}
geographic adjacency
Urban and
Spatial planning
Spatial and geographic

}
dissimilarity
Spatial development,
Regional policy
Spatial and geographic
distance and mobility

Spatial and geographic

extent and fragmentation
} Spatial and Territorial
administration

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Comparing the one-point
economy and the spatially
extensive one-point
categories economy spatially
extensive
Market Uniform, Structured and
homogenous (same dissimilar in space
prices)
Input (costs) Near-average Spatially dissimilar
(local)
Competition Perfect (on both Imperfect
Input and Product (geographic
markets) monopoly)
Economic reactions Identical Different (local
culture and
particularities)
Market information Perfect Spatially asymmetric
Market behaviour Rational Spatially restricted

Consumer Homogenous
rational
Spatially
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preferences inhomogenous
Regional economics among
sciences

Economic Sciences

Regional Economics

Geographic, technical
and legal sciences

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The elements of Regional
Economics
Location theory

}
Theory of Economic
Space (spatial Microeconomics
structures, city and
settlement networks,
markets in space,
agglomerations)

Regions, regional
economic growth and
development in space
}
Macroeconomics

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Location theories and locating
factors
Theory of agricultural location (von
Thnen)
Theory of industrial location (Weber)
Location of commerce
Location of services
Theory of choosing a habitation
location (Alonso)

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Different interpretations of
Location
National level:
Tax regime, customs, tariffs and duties
Economic and legal regulations
Economic and population growth
Political and economic stability
EU membership
Regional level
Quantity and qualification of workforce
Proximity and access to motorways
Vicinity of national frontier
Economic structure
Local level
Price and appropriateness of the real estate (land)
Accessibility of utilities
Local taxes and subventions
Local industry
Cooperative opportunities
Schools, universities and training facilities
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Webers theory of Industrial
Location
Logically speaking, the first regional
economic theories were on Industrial
Locations (historically speaking,
though, the first ones were on
agricultural locations.)
The founder of the Economic Theories
of Industrial Location was Alfred Weber
His magnum opus was published in
1909: On the Locations of the
Industries (ber den Standort der
Industrien)
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Locative factors in Webers
theory
Such factors which transform the
conditions of productions favourably
to producers (agglomerative factors)
Benefits arising from the proximity of
either resources (raw materials) or
markets (transportation costs)

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Effects and benefits in Webers
Theory
Agglomerative benefits and transport
costs act in opposing directions
Their equilibrium determines the
optimal location
The agglomerative effect acts towards
the highest concentration of activity
but the requirement that locations
should be in the proximity of resources
and labour, as well as consumers and
markets, acts in the opposing direction.
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Agglomerative benefits
1. Benefits arising from an increase in size
of a particular plant (economies of
scale)
2. Benefits arising from the increase in the
number of businesses in the same
economic sector (specialised suppliers,
qualified work force, availability of
management and technical know-how),
known as localisation benefits
3. Urbanisational benefits arising from the
infrastructure and size of a big city
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Agglomerative drawbacks
1. Increased price of work force and
required land
2. Drawbacks of congestion (noise,
pollution, criminality, social
problems)
3. As concentration increases, some of
the markets will become more
distant, thus increasing
transportation costs

13
Main groups of Industrial
Location Theories
Cost Minimising theories
Price is a given factor, producers have no
influence
Location of competitive companies does
not affect sales
An increase in profit can only be achieved
by cutting production and transport costs

Webers Theory is a cost minimising theory

14
Main groups of Industrial
Location Theories
Profit Maximising theories
Price is not a given factor; it depends on
The location of customers
The location of producers
The location of competitive firms
The strategy of competitive firms
Demand is not focussed in a single
point, but rather, it is spatially
distributed

15
Examining factors:
transportation
Some raw materials are to be transported,
others are not (air, water, etc.)
Non-transport cost differences exist in raw
materials, intermediary and end-products,
e.g.:
Depth of mines
Quality of raw materials
All non-transport cost differences are
converted into transport costs
This is a reverse iceberg model

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Suppositions in Webers model
Demand for a product exists at a single
point in space
Two kinds of raw materials exist, in two
points, removed from both the market
and each other
The market is perfectly competitive
The sale price of the product is given
and inelastic
All possible locations implement the
same technology, therefore costs
incurred must be the same everywhere
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Question: where to settle
industry?
Webers Theory deals with the
problem of finding an optimal location
for industry.
What are the scenarios?
Locating the industry near the market
Locating it near the raw material
Find an intermediary compromise
location

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Scenario I: locating near the
market
An industry will settle near the consumer
market, if
The final product is heavier than the aggregate
weight of the raw materials, energy sources and
intermediary products, or otherwise, if
The final product is not heavier than the
aggregate weight, but transportation costs of the
final product are so high that they would over-
compensate the difference in weight.
Typical examples:
Beverages (high water demand)
Paints, thinners, etc. (again, high water demand)
Perishable goods (foods, etc.)
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Scenario 2: locating near raw
materials
An industry will settle near the raw materials
or sources of energy, if the industry is heavily
dependent on these.
Examples:
Construction materials
Oil refining
Smelting (blast furnaces)
Alimentation (flour milling, sugar and canning
industry)

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Scenario 3: other locations?
What if the industry does not produce for a
single market only, and/or requires more than
just a few raw materials and energy sources?
If there is no single item (either on the input
or output side) that would dominate the
production, where should we locate the
industry?
The solution: finding a compromise location!
How do we define such a location?

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Defining a compromise location
Weber uses a formula to define a locative criterion
He defines material indices:
For each tonne of product, an amount of each
component (raw material, energy, etc.) is needed
These quantities must be put in during the process
One tonne of final product is the output
a1, a2, a3, a4, etc.
Aggregate amount of quantities to be moved:
ai+1
This amount is called the weight of the location
(T)
Using these indices, defining a location becomes
more straight forward
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Three possible locations
1. An industry will be located near an input
material if there exists a material index ai,
which exceeds half the sum of all input weights
(i.e.: half of the weight of location, T), such that
ai > T 2
2. The industry will be located near the product
markets if the weight of the product exceeds
half the sum of all input weights (ie.: half of the
weight of location, T), suchthat1> T2, or T<2.
3. A compromise location will be chosen if none of
the above conditions hold true, i.e.: ai< T2,
and 1< T2 or T>2.
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Working with a compromise
location
If there is only a single raw material and a single
product market, there cannot exist a third,
intermediary or compromise location, since one
of the material weights will probably exceed half the
location weight.
Should they be exactly equal, choosing an
intermediary location is still unlikely to be
beneficial, as the costs of loading and unloading
between the two end points (raw material or the
market) will increase costs. Even randomly choosing
one will be cheaper.
Compromise locations can only be defined when
there are at least two raw materials and one
market, or one raw material and two markets.
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Finding a compromise location
Lets suppose we have
Two raw materials (A and B)
One market (C)
located geographically as shown below:

C
B
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Finding a compromise location
We need to find a point P inside the bounding
triangle with the smallest possible associated
import and export costs.
Were looking for a certain centre of mass of the
triangle, but not the geometric centre of mass.

P
C
B
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Finding a compromise location
Were after a point where the product of the transport
tariffs and the import and export costs
w1t1s1+ w2t2s2 + w3t3s3min
wi = point-specific import & export weights
(material&product index)
ti = transport tariffs of materials and products
si = distances from the end points, defining the distance
from P
A

P
C
B
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A possible compromise location
A

C
B

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Compromise locations in real
life
Lets suppose that we have two raw
materials and one market, just like before,

A
here,
here, C
and here.

B
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A possible compromise location
We do the maths again, and we identify our
compromise location.

P C

Lets see this on our map now.

B
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And here it is.

P C

Can we spot any problems?

B
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Our optimal compromise location
is in the middle of nowhere!
No roads.
No railroads.
There arent even any towns close by!
A

P C

B So can this be optimal?

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Wouldnt it be more practical to
have our location elsewhere?
Here, because its
close to the river?
Here, because
theres a road? Here, because
its near a town?

P C Here, because
of the railroad?

Webers model can give some strange results.

B
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 Lets take a scenario just like
before:
A
C

B
Where will we find a compromise location?

34
 Webers model offers this
solution:
A
C
P

B
Surely, this cant be a feasible location.
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Associated mathematical
problems
There is no simple one-step solution
for determining a compromise location
An iterative process needs to be carried
out, which takes several additional steps
There is no single guideline iteration for
solving the problem
Possible solutions have been published
(such as Harold Kuhn and Robert
Kuennes solution)
Even if a compromise location is found,
it may not be practical in real life
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On the issue of workers
We need to take into consideration the
issue of workers as well
We need workers for the factory (obviously)
Workers tend to live somewhere
At the time of the formulation of the
theorem, commuting was not an everyday
phenomenon, so a given workforce was
only available locally
From Webers point of view, the advantages
and disadvantages arising from the level of
training of the workforce would only be
reflected in their wages
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Webers formulation of this
question
Lets suppose that there exists another
city, where wages are lower compared to
the optimal (compromise) location
(which was determined through
transport costs), then
Considering possible savings in costs
and expenses, would it be worthwhile for
the industry to locate nearer to where
the workforce lives (and bear the
additional transport costs on both input
and output side)?
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Webers solution
As previously, Weber projects labour costs
on a quantity of final product (one tonne)
He first calculates the amount of labour
required for the production of a tonne of
final product.
The then divides this quantity by the
aggregate weight of all materials going in
and out of the factory, i.e.: the weight of
the location
We get an index number, which he calls
labour coefficient (Arbeitskoeffizient, A)
We can now directly work with labour costs
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What this means
If A1 is the labour coefficient at the
optimal (with the supposedly higher
labour costs), and
A2 is the labour coefficient at the city
with the supposedly lower labour
costs, then
The difference A1-A2 will indicate the
savings in labour expenditure.

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Working this out with formulae
If the new location would be at a distance of
S kilometres from the optimal location, and
the cost of transportation would be t per
tonne, a switch of location would only be
worthwhile, if
TSt < A1-A2
In such a situation, we would replace some
of the labour costs with additional transport
costs.
Hopefully, this would result in a saving.
If not, DONT do it!
This substitution effect has become a
fundamental part of location theories.
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About market effects
When treating labour, it becomes obvious
that Weber does not consider the effect
companies have on wages:
If a new factory locates in a town, this will
have an effect on wages (increase) so the
calculated savings on wages will not be
realised.
Even though Webers Model is considered
to be a cost-minimising approach, by
disregarding market responses we cannot
even calculate cost savings.
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Agglomeration effects
ag glom er ate, vb:
to form or be formed into a mass or cluster
as firms in related industries cluster
together, costs of production may decline
significantly
firms have competing multiple suppliers
greater specialization and division of labour
Even when competitors agglomerate,
benefits may be reaped, as the cluster
attracts more suppliers and buyers
Cities grow because of such effects!
It relates to two main ideas:
Economies of Scale
Network Effects 43
Advantages of agglomeration
Influx of new information and
practices
This can bring down fixed costs of
production
As fixed costs fall, a stage of
economies of scale is reached

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Disdvantages of agglomeration
City growth may only be persistent if
advantages constantly outweigh
disadvantages
Adverse effects may appear
Congestion
Pollution
Criminality
Other negative externalities of clustering
Pricing power of the firms will decrease,
as shortage of labour becomes
apparent 45
Back to Webers Model
According to Weber, companies have
two alternative paths to take:
1. Establish two separate factories, each near
its own suppliers and markets, at optimal
distances between the two
2. Establish a single factory with the combined
production capacity of the hypothetical two
factories, which would be located at a not
optimal site, but the additional transport
costs would be covered by the savings
through economies of scale
Which alternative should one choose? 46
Sounds familiar?
It should; the logic of solving this problem is
exactly the same as the problem of labour.
A move away from the optimal location results in
an increase in costs.
However, savings will be realised in some fixed
costs that dont increase with size:
Administration
Buildings and real estate
Production and development costs
Marketing
If the benefits of economies of scale outweigh
the losses through locating away from the
optimum, its worthwile to build a larger factory
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Working this out with formulae
Lets consider fixed costs C and the mass
of products from each plant W1 and W2
As previously, T is the weight of the
location, S is the distance from our
The criterion for building a larger factory
is therefore
2C C
T S t
W1 W2 W1 W2

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To wrap up Webers Model
Weber considers each factor one after
the other.
If we began by leaving the optimal
location for benefits of cheaper
labour, we then start out from this
new point when we consider the
effects of agglomeration and
economies of scale
Savings have to cover an increase in
the cost of labour as well!
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To wrap up Webers Model
Even though it has a number of known
flaws, Webers model remains a
cornerstone in regional economics
It has been a logical guideline for
locating industry for several decades
Even today it has some applications

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