A Transactions-Cost Theory of Agglomeration Economies
July 11, 1995 In contrast to recent work in Regional Economics which emphasizes the role of an industry's scale in generating agglomeration economies, this paper emphasizes the importance of an industry's composition, that is, the number of firms generating agglomeration economies. As most recent work in this area, we assume that production is characterized by the use of non-tradable intermediate goods produced with decreasing average costs. Concentration leads to competition for inputs among final good producers, and thus provides a governance structure that mitigates the commitment problem intrinsic in the relationship between the intermediate goods' suppliers and final good producers. Hence, the paper establishes a link between the number of firms in the industry in a particular region, variety of industry-specific inputs, production costs, transaction costs, and producers' profits. Furthermore, the paper demonstrates that the scale effect and the composition effect can re-enforce each other. The paper's theoretical framework is applied to examine the concentration of the automobile industry in Michigan.
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