The Least Cost Theory
The Least Cost Theory states that a firm will locate in an area where the labour and raw materials are cheapest. However, it makes many assumptions. In particular:
- Firms have no perfect knowledge about costs.
- Firms are affected by personal preferences, especially small, new and family-run firms. For example, a family-run firm is more likely to operate in the family's hometown, even if it is not the most profitable there.
A maximiser has perfect knowledge about costs, and will located in the least-cost area. A satisficer, by contrast, is satisfied with the profits made even if it is below the maximum.
Industrial Agglomeration
Industrial agglomeration refers to the clustering of a large number of firms in a related area.
Agglomeration economies
Agglomeration economies are the economic benefits brought by agglomeration:
- Infrastructure is better developed.
- Skilled labour of that particular industry is attracted to the area.
- It encourages more investment in that area.
- Firms can purchase similar inputs in bulk, and have a closer relationship with suppliers and buyers.
- Information can be exchanged between firms.
- The possiblity of joint ventures is higher.
- They can share sources of innovation.
All of the above can cut production costs and increase productivity.
Agglomeration diseconomies
However, there are also disadvantages:
- Traffic congestion
- Pollution
- ↑ Wages and land rent
- Existing facilities may become inadequate
Industrial Inertia
Sometimes, even though the original locational advantage of locating a plant in an area is gone, the plant still decides to stay in that area.
There are many reasons to explain this:
Pull factors of the old site:
- Existence of large markets
- Existence of a pool of specialised labour
- Existing infrastructure is good
- Good transport network
- Agglomeration - linkages with related firms
Push factors of the new site:
- Moving incurs high costs, especially for fixed capital like machines
The personal preference of the owner is also significant, especially for small-scale firms employing single-point production. Sometimes, government policy also discourages moving away as this will lead to unemployment.
Footloose Industries
A footloose industry is one that can be located in most places because locational factors are not very important.
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