.

Theoretical
Considerations

© 2012 Pearson Education, Inc.

• Where to allocate the production of:
• A)clothes,
• B)computers,
• C)soft drinks,
• D)finance institutions,
• E)banks,
• F)beauty salons?
• Urban or rural region?
• Developing or developed countries? Why?

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Factors of Location
(Labor, Land, Capital, Managerial & Technical Skills)

• Labor
1) The most important factor in Location
2) In countries with high BR, the supply of labor tends to be
relatively high and labor costs are low.
3) In developed countries the BR is low and labor is
relatively expensive.
4) These trends shape the wiliness of firms to become
more capital-intensive, when labor is cheap – not.
5) As labor is relatively mobile factor, regional differences
in the supply and demand for labor (wage rates) should
move towards equilibrium by labor migration.
3

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 Labor
6) Unemployment payments and workers’
compensation can reduce the labor migration
7) Firms will pay relatively high wages for skilled,
productive labor (human capital) if the cost is justified
by higher output and profits
8) Myth: Firms always want the cheapest labor
possible
9) Relative contribution of labor varies by industry
10) Labor is the only input that is able to resist the
conditions of exploitation, to go on strike or to unionize
(labor unions)
4

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 Labor
11) In addition to the cost of labor, firms must
consider working conditions, health standards,
pensions and health benefits, vocations and
holidays, worker training
12) Advantages can be gained by companies
that relocate to or purchase from newly
industrializing countries

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Factors of Location (continued)
• Land
– At the local level, availability and cost of land are the
most important locational factors affecting firms location
decisions
– Accessibility (nearness to city) is primary determinant of
the cost of land

FIGURE 5.3 Land costs decline with

distance from CBD because of lessened
accessibility and increased transport
costs. Trade-offs are needed.
6

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Land
1) Firms that must have accessible land – to labor, to
each other, to specialized pools of information, to
urban services, such as legal firms – will pay very
high rents in order to locate near the city center.
2) Firms that do not require access to clients,
suppliers and services (large manufacturing firms)
locate on the urban periphery where land costs are
low but transportation costs are high

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Capital
– Fixed capital: machinery, equipment, plant buildings
– The age of the capital stock of a region and how recent
the technology is greatly affect its overall productivity
levels.
– Financial capital: revenues, corporate profits, savings,
loans, stocks, bonds, etc.
• Most mobile factor of production
• Can be transferred instantaneously, with almost no cost
• Finance sources
– Personal funds, family, friends
– Banks, lending institutions
– Sale of stocks and bonds
– Capital intensification: when capital substitutes for labor
– Advantages and disadvantages of capital intensification? 8

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Factors of Location (continued)
• Capital (continued)

FIGURE 5.4 The process of capital intensification is a long-term trend under capitalism.
When labor costs are low or jobs are hard to automate, this is less likely to occur. 9

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Managerial and Technical Skills
– Management
• Allocates resources,
• raises capital,
• negotiates financial markets,
• monitors competition,
• government rules and
policies,
• makes investments,
• personnel decisions,
• marketing, etc.
• Skilled and well paying labor
• Requires linkages to other
firms (cluster) 10

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Factors of Location (continued)

FIGURE 5.5 Corporate headquarters in the United States, 2008.

11

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Technical skills
– Innovation, research and development (R&D)
– The R & D required for new products is a large and
expensive process, involving long times between
invention and production, that is impossible for small firms

FIGURE 5.6 Silicon Valley

is the world’s largest region
for producing computer
software.
12

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
U. S. expenditures for R&D 2.6% of GDP
Japan 3.4%
South Korea 3.2%
Germany 2.5%
UK 2.3%
France 2.1%
China 1.4%

13

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 The Weberian Model (Alfred Weber, 1929)
• Emphasizes transportation costs in industrial
location decisions
• Assumptions:
– Transportation costs are a linear function of distance
• Who knows what this means?
– Producers face neither risk nor uncertainty
– Implies that demand for a product is infinite at a given
price
• Elements
– Raw materials and finished goods (products)
– Location (site of raw material, market)

14

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 The Weberian Model (continued)
• Elements with raw materials (continued)
FIGURE 5.7a One localized raw material
located at RM. Total transport costs (TTC) are
lowest at RM, as in primary sector activities.

FIGURE 5.7b One localized raw material

located at RM. Total transport cost (TTC) are
lowest at the market (M). 15

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 The Weberian Model (continued)
• Elements with raw materials (continued)

FIGURE 5.9 Bottled and canned soft-drink manufacturing exemplifies a form

of production that is market oriented. 16

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 The Weberian Model (continued)
• Weber today
– Transportation costs are
declining
– Brainpower is displacing
muscle and machines,
and transforming natural
resource
– Real-world patterns are
evolving

17

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Technique and Scale Considerations
• Establishing a manufacturing plant in a market
economy involves the interdependent decision-
making criteria of…
– SCALE (the size of the total output) and
– TECHNIQUE (the particular combination of inputs that
are used to produce an output)
• Firms can substitute among inputs to minimize their costs
(e.g., machinery for labor)
– Limits to substitution vary by industry

18

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Technique and Scale Considerations
(continued)

• Scale considerations
– Economic scale: level of output
– Principles of Scale Economies
• Division of labor
– Speeds up production
– Allows use of relatively unskilled labor
– Requires larger scale and larger labor pool
– Increasing number of shifts uses capital more efficiently
• Economies of Scale (scale economies) refer to the reductions
in costs associated with the production of output in large
quantities
• Large firms usually pay less for material inputs than small ones
19

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Technique and Scale Considerations
(continued)

– Principles of Scale Economies

(continued)
• Scale economies portrayed as a
curve of Long Run Average Costs
(LRAC)

FIGURE 5.10 Variations in long-run average cost curves

(LRACs). Organizational and technical constraints make the
optimal level of output vary by industry and individual firms.
20

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Technique and Scale Considerations
(continued)

• Scale considerations (continued)

– Vertical Integration and Diversification
• Vertical integration: firm controls more “up and down” in the
total production process
– Ex.: some large car companies own iron ore companies to produce
their own steel (“down”); and their own dealerships (“up”)
• Horizontal integration: firm controls an increasingly large
market share of a given niche in a particular industry
• Diversification: firm enters a different product market from the
one in which it has traditionally been engaged

21

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Technique and Scale Considerations
(continued)

• Scale considerations (continued)

– Interfirm Scale Economies:
Agglomeration
• Agglomeration economies:
benefits that firms gain by
clustering near other firms in the
same field

FIGURE 5.11 Advertising agencies in Manhattan must

cluster near Madison Avenue to achieve the agglomeration
economies so essential to labor-intensive, information-
intensive, white-collar, high-value-added functions such as
producer services.
22

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Technique and Scale Considerations
(continued)

• Scale considerations (continued)

– Interfirm Scale Economies: Agglomeration (continued)
• Production linkages: accrue to firms locating near other
producers that manufacture the same basic raw materials—
distribution and assembly costs are reduced.
• Service linkages: occur when enough small firms locate in
one area to support specialized services
• Marketing linkages: occur when a cluster is large enough to
attract specialized services
• Urbanization or industrial-complex economies: a
combination of production, service, and marketing linkages
concentrated at a particular location.

23

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Technique and Scale Considerations
(continued)

• Evaluation of Industrial Location Theory

– Comparison of optimal patterns to the real world reveals
decisions not always optimal
• Firms may have more than one critical site or situation factor, each
favoring a different location
• Even with just one critical factor, more than one critical location
may emerge
• Incomplete information makes it difficult for firm to calculate and
compare costs of competing locations
• Firms may make decisions based on company history and inertia
• Government loans, grants, regulations, etc. influence decisions
• Non-economic factors play a role, especially for “footloose”
industries
24

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 How and Why Firms Grow
• Firms expand for two reasons: survival and growth
– Today, small firms have less chance of becoming a
corporate giant than they did 100 years ago
– Growth strategies are either integration or diversification
• Horizontal integration predominated from 1890s to early 1900s
• Diversification predominates since 1950s
• Removal of competition through absorption leads to oligopoly
(control of a market by a small number of firms or producers)

25

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 How and Why Firms Grow (continued)
• Methods to grow are internal (retention of funds,
etc.) or external (acquiring assets)
– Often involve additional factories and a change in
geography
– Backward integration: firm takes over responsibilities
that previously belonged to suppliers
– Forward integration: firm begins to take control of
outlets for its products
– Firms usually expand in geographically adjacent or
culturally similar environments

26

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Geographic Organization of Corporations
• Organizational Structure
– Firms are usually
hierarchically
organized
– Several basic
formats or
models

FIGURE 5.13 Organizational structures: (a) functional orientation; (b) product

orientation; (c) geographic orientation; and (d) customer orientation. 27

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Geographic Organization of Corporations
(continued)

• Administrative Hierarchy
– Even in manufacturing, a large proportion of employees
are involved in nonproduction activities; this occurs
because of…
• Substitution of capital for labor
• Growth of activities associated with administration,
management, research, advertising, finance, legal services,
etc.
• Strategic head-office functions tend to cluster in a relatively
small number of metropolitan areas
– Access to other firms, clients, suppliers, advertisers, repair, etc.
– Face-to-face contacts and business meetings needed

28

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Economic Geography and Social Relations
• The production of goods is a social (not purely
individual) process
– Crucial social relation of production is between owners of
the means of production and the workers employed to
operate these means
• Relations among owners
– Capitalists make independent production decisions under
competitive conditions
– Competition requires producers to apply a minimum of
resources to achieve higher outputs
– Competition is the source of capitalism’s immense
success as a mode of production
29

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Economic Geography and Social Relations
(continued)

• Relations between Capital and Labor

– Cooperative and/or confrontational
– Surplus value (the value produced by workers that exceed
their wages) is the basis for profit
– Competition forces management to invest in technology and
research to increase productivity
• Competition and Survival (geographically)
– Relocation, mobility of capital
– Emergence of the international division of labor resulted in
deindustrialization in the old industrial regions and a
precarious export-led industrial revolution in part of the
developing world
30

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 The Product Life Cycle

FIGURE 5.14 A typical product life cycle. Stage 1 is the monopolistic

phase; Stage 2 entry of competition; Stage 3 a large share of the market
has been lost to new products and other companies. 31

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Business Cycles and Regional Landscapes
• Capitalism is a society and economy that is
notorious for its instability (booms and busts)

FIGURE 5.15 Kondratiev waves of economic activities. Each wave lasts approximately
50 years and has four phases of activity: boom, recession, depression, and recovery. 32

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Business Cycles and Regional Landscapes
(continued)

• First Kondratiev Wave

– Centered on textile industry, 1770–1820s
• Second Kondratiev Wave
– Focused on railroads and iron industry, 1820–1880/90s
• Third Kondratiev Wave
– Fordist industries, peaked around World War I,
1890s–1930s
• Fourth Kondratiev Wave
– Propelled by World War II, peaked in 1960s, centered
around petrochemicals and aerospace
33

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Business Cycles and Regional Landscapes
(continued)

• Information Technology: The Fifth Wave?

– Some scholars suggest that a Kondratiev fifth wave began in
1980s with information technology
– Leading current wave are business services (producer services)
• Business Cycles and Spatial Division of Labor
– Given the fluidity of capitalism, there is no reason to expect that
any region will experience production advantages indefinitely.
– As firms located in regions, in different eras, they shaped the
landscape
– When obsolescence occurs, firms leave
– Comparative advantages shift from era to era and from place to
place
34

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 The State and Economic Geography
• The economic landscapes of capitalism are not simply
the products of “free markets”
• The extent of state involvement varies historically and
geographically
• Legal system shapes economies
• Governments also set fiscal and monetary policies
– Fiscal policies: determine how governments spend money
– Monetary policies: determine the money supply, almost all
nations use a national bank to manage their money supply
– Construction of infrastructure (transportation and
communication networks)
– Agent in international issues
35

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 The State and Economic Geography
(continued)

FIGURE 5.16 Origins of federal government tax revenues, 2008.

36

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 The State and Economic Geography
(continued)

FIGURE 5.17 The Federal Interstate Highway System. 37

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 The State and Economic Geography
(continued)

FIGURE 5.19 Federally owned lands. 38

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
1. How is labor different from other inputs that firm
use?
2. What determines the amount and type of an
industry’s demand for labor?
3. Do firms always purchase the cheapest labor?
Why or why not?
4. What is human capital and why it is important?

39

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
 Home work:
Factors of Location
1.Labor,
2. Land,
3.Capital,
4.Managerial & Technical Skills
5. The Weberian Model
6. Principles of Scale Economies
7. Vertical integration (examples)
8. Horizontal integration (examples)
9. Diversification
10. Agglomeration economies
11. Organizational Structure (examples)
12. The Product Life Cycle
13. Business Cycles
14. Fiscal and monetary policies (examples)
40

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.
15. How does land influence the location of a firm?
16. How does input intensification influence the location of a
firm?
17. Compare and contrast scale and agglomeration
economies.
18. Contrast horizontal and vertical integration.
19. What is the product life cycle model and how does it
influence the location of firms?
20. Where to allocate the production of: clothes, computers,
soft drinks, finance institutions, banks, beauty salons? Urban or
rural region? Developing or developed countries? Why?

41

Stutz & Warf; The World Economy, 6th Edition © 2012 Pearson Education, Inc.