Economies of agglomeration

In urban economics, economies of agglomeration are the benefits that firms obtain by locating near each other ('agglomerating'). This concept relates to the idea of economies of scale and network effects. As more firms in related fields of business cluster together, their costs of production may decline significantly (firms have competing multiple suppliers; greater specialization and division of labor result). Even when competing firms in the same sector cluster, there may be advantages because the cluster attracts more suppliers and customers than a single firm could achieve alone. Cities form and grow to exploit economies of agglomeration.

Diseconomies of agglomeration are the opposite. Additional competition drives down pricing power. For example, spatially concentrated growth in automobile-oriented fields may create problems of crowding and traffic congestion. It is the tension between economies and diseconomies that allows cities to grow but keeps them from becoming too large.

Agglomeration economies are closely associated with economies of scale and the network effects mentioned above. A positive outcome, agglomeration economies, is achieved only if the benefits outweigh the disadvantages. The ultimate result of agglomeration economies is the formation and the growth of a city.

The basic concept of agglomeration economies is that production is facilitated when there is a clustering of economic activity. The existence of agglomeration economies is central to the explanation of how cities increase in size and population, which places the phenomenon on a larger scale. The concentration of economic activity in cities is the reason for their existence, and they can persist and grow throughout time only if their advantages outweigh the disadvantages.

When firms form clusters of economic activity, there are particular development strategies that flow in and throughout this area of economic activity. This helps to accumulate information and the flow of new and innovative ideas among firms for the achievement of what economists call increasing returns to scale.

Increasing returns to scale, and economies of scale, are internal to a firm and may allow for the establishment of more of the same firm outside the area or region. Economies of scale external to a firm are the result of spatial proximity and are referred to as agglomeration economies of scale. Agglomeration economies may be external to a firm but internal to a region. It is important to note that these increasing returns to scale are a major contributing factor to the growth of cities. Agglomeration economies exist when production is cheaper because of this clustering of economic activity. As a result of this clustering it becomes possible to establish other businesses which may take advantage of these economies without joining any big organization. This process may help to urbanize areas as well.

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