Economics 5

Economics

Location economies:

Introduction:

Economic growth can be associated with the growth in urban areas, the urban areas are densely populated and this is where we have job opportunities, high levels of productivity and many firms. Urban areas have differing functions in that some are political cities, administrative cities, industrial cities, religious cities, educational cities, commercial cities, tourist cities and finally military cities.

In economics the size of an urban area is determined by the level of output by the firms and households and not by the size of the urban area. Urban area emerge when firms tend to gain opportunity cost by locating in the area, this aids the firm to generate more profits in the area. Urban areas will generate demand for labour who work in the firms that are located in the area, as more and more labour is demanded labourers tend to locate near the city in order to save on transport cost, as more labourers locate near the city then the demand for goods in the city will expand leading to more expansion of the city.

This paper discusses the factors that a firm will consider when locating its production process, this include transport costs, production cost and amenities.

Location economies:

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A firm will locate in an area where it reduces both its procurement costs and also the distribution costs, procurement costs are those costs associated with the transportation of the raw materials into the firm. Distribution costs are those costs associated with transport costs in distributing the goods and services to the consumers.

When the procurement costs are lower than the distribution costs then a firm will locate near the source of its raw materials in order to gain competitive advantage through its reduction in its cost of production.

When the distribution costs are lower than the procurement costs then the firm will locate near the market, this reduces the costs of producing the goods and therefore the firm gains competitive advantage.

If the firm is a monopoly then the firm does not necessarily take into consideration the location, a firm will also locate near its competitors in order to experience a reduction in the costs of production, they will locate near competitors in order to reduce the cost of marketing because consumers are closer to them, the consumers will have a variety of goods and services to choose from.

Therefore the firm will locate in an area where there is a possibility of reducing the price of production. The level of output by firms in an area will determine the economic size of the area, when output by firms and household is high then the area experiences economic growth.

Production costs:

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Cost of energy:

Minimising the cost of energy is one of the factors that a firm will consider when locating its production process, the reduction in the cost of energy will result into a reduction in the cost of production. This is reason why most of steel and iron producing firms will locate near coal mines. This way they are in a position to save on energy costs because coal is cheaper than any other source of energy.

Firms will also locate in areas where there is abundant supply of electric power in order to save on costs of energy where other sources of energy tend to be more expensive than others, minimising the cost of energy in the economy will therefore result into m a reduction in the cost of production and this will reduce consumer prices. When consumer prices are reduced then there will be increased demand for goods and services in the economy promoting growth.

Cost of labour:

Firms will also locate in areas where the cost of labour is low, in areas where the cost of labour is low then the cost of production is low therefore the final price of its products will be low and competitive, for this reasons most firms locate less developed countries where the cost of labour is low as compared to developed countries where the cost of labour is high.

Labour is a factor of production in almost all firms, as depicted by the cost push inflation theory by Keynes then labour cost will increase or decrease the level of final prices in the economy, therefore if a firm is able to reduce the cost of production through tapping low paying labour then the final prices of its products will be low.

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Cost of land:

Land is also an important factor in the production process, firms will locate on land or even use land in producing agricultural products, therefore a reduction in the price of land wills highly contribute to a reduction in the cost of production. This will reduce the final price of goods which will highly benefit the economy in terms of growth.

External economies:

External economies can be defined as the advantage that a firm gains as a result of producing more, a firm will gain advantage if it finds a location where there is a large market and the firm expands its production process. As the number of units produced increase then the fixed costs of the firm are distributed to more units and this is what is referred to as economies of scale, therefore an increase in the market size wills reduce the cost of production of a firm and therefore the final price of its goods will be low.

Amenities:

Firms will locate in area where there is abundance of amenities. The abundance of social amenities such as hospitals, schools will encourage households to locate in these areas, because the households are both providers of labour into firms and at the same time consumers of final products. Therefore an increase in amenities in a location will attract labour into the area who will be also consumers of products encouraging economic growth.

Export:

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Exports tend to encourage growth in the economy. Exports are sources of foreign currencies and also help solve the problem of balance of trade. Exports will also create market for excess production encouraging higher levels of production in the economy due to availability of a larger market. Firms will only exports goods only if the prices of their commodities are lower in the export market.

Exports will also encourage specialisation where economies will specialise only on those goods and services it has both absolute and comparative advantage. Specialisation encourages efficiency and effectiveness of the production process reducing the cost of production.

Therefore the export market will encourage growth and development in an economy when the exports bring in foreign currency, encourage the expansion of production of goods and services and at the same time improve the balance of trade an economy.

Conclusion:

The size of an urban area is determined by the level of output by the firms and households. Urban areas emerge when firms tend to gain opportunity cost by locating in the area which helps the firm to generate more profits in the area. Urban areas will generate demand for labour who work in the firms that are located in the area, as more and more labour is demanded labourers tend to locate near the city in order to save on transport cost, as more labourers locate near the city then the demand for goods increases.

A firm will locate in an area where it reduces both its procurement costs and also the distribution costs, when the procurement costs are lower than the distribution costs then a firm will locate near the source of its raw materials and when the distribution costs are lower than the procurement costs then the firm will locate near the market.

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Labour and land are factors of production, labour cost as depicted by the cost push inflation theory by Keynes then labour cost will increase or decrease the level of final prices in the economy, therefore if a firm is able to reduce the cost of production through tapping low paying labour then the final prices of its products will be low. Land is also an important factor in the production process, firms will locate on land or even use land in producing agricultural products, therefore a reduction in the price of land wills highly contribute to a reduction in the cost of production.

The abundance of social amenities such as hospitals, schools will encourage households to locate in these areas, because the households are both providers of labour into firms and at the same time consumers of final products. Therefore an increase in amenities in a location will attract labour into the area who will be also consumers of products encouraging economic growth.

Therefore the firms will encourage growth if only the above advantages are associated with the area they locate their production process, they will consider all the factors discussed in this paper. When firm increase their production then this eventually encourages economic growth and development.

References:

Anthony Samuelson (1964) Economics, McGraw-Hill publishers, New York

Brian Snow (1997) Macroeconomics: introduction to macroeconomics, Rout ledge publishers, UK

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Stratton (1999) Economics: A New Introduction, McGraw Hill Publishers, New York

Philip Hardwick (2004) Introduction to Modern Economics, Pearson Education Press, UK