Location theory

Updated: Aug 20, 2021

A body of theory which attempts to explain and predict the locational decisions offirms and the spatial patterns ofindustry and agriculture which result from aggregates of the individual decisions. The main aim of locational theorists has been to integrate the space dimension into conventional economic theory. Location theory originated in the work of Von Thunen and Weber, who developed models of location for firms in an environment of perfect competition. Both assumed that entrepreneurs attempted to maximize profits in the face of a given price fixed by the market and outside their control, with perfect knowledge of the cost characteristics of all locations. As a result of these assumptions, locational decisions were explained solely in terms of differences in production and transport costs between sites. The principal difference between the two was that von Thunen began with an agricultural producer in a fixed location and attempted to explain his choice of product, whereas Weber took the case of a manufacturer with a given product and tried to explain his choice of location. Until late 1970s, most work on location theory followed Weber and von Thiinen in assuming perfect competition and concentrating on cost minimization models, taking sales revenue as constant over all locations. The simplest of such models assume that producers have a market at one location and a raw-material source at another, with the problem being to predict the choice of location of the firm. If the assumption is made that production costs are constant over all locations, then the problem is simply that of finding the location which minimizes transfer costs. Although the assumptions clearly create a highly simplified mode!, several definite predictions can be made which tend to be consistent with the behaviour of firms for which transfer costs are a high proportion of total costs. Briefly, some oUhese predictions are:

(a) If a production process involves loss of weight (e.g. ore refining), loss of bulk (cotton ginning) or decrease in perishability (fruit canning), the firm will locate to the raw-material source. (b) If the process involves gains in weight, bulk or perishability, the firm will locate to the market. (c) Location between the market and raw-material source will not in general occur, for two reasons: first, freight rates per ton-mile diminish as the distance carried increases, which makes one long haul cheaper than two hauls with the same total distance, and, second, a central location would mean loading artd unloading charges for both raw material and finished product rather than just one of them.

Obvious generalizations of this model have been made by introducing several markets and raw-material sources and by removing the assumption of equal production costs over all locations. However, as long as the assumptions of profit maximization and given product price were retained, the emphasis lay on determination of least-cost locations, their characteristics and the patterns of industrial location to wbich they gave rise. Towards the beginning of the 1980s emphasis shifted to the relation between location and demand, white the assumption of perfect competition has tended to be replaced by an assumption of imperfect competition. The idea of profit maximization as the basic motivation of the firm has, however, remained. Location theory can be viewed as an extension of the theory of the firm to analysis of location decisions, whereas in conventional microeconomics only decisions on price output, investment and seiling expenditures are normally considered.

Reference: The Penguin Dictionary of Economics, 3rd edt.

Sources & references
Risk disclaimer
James Knight
Editor of Education
James is the Editor of Education for Invezz, where he covers topics from across the financial world, from the stock market, to cryptocurrency, to macroeconomic markets.... read more.