This lesson explores the clustering of businesses and resources known in economics as agglomeration, including a definition of the concept along with a discussion of the underlying theory and process.
Definition of Agglomeration
Have you ever wondered how Detroit became the center of American auto manufacturing? It can seem counter-intuitive that so many car makers would choose the same city as their headquarters.
In fact, the clustering of automobile manufacturing is a prime example of agglomeration, a powerful concept in economics that has a large influence both on the way urban areas develop and where companies choose to locate. In this lesson, we’ll discuss the basic concept of agglomeration along with its underlying process and theories. We’ll also explore the practical effects of agglomeration in the real world.The term agglomeration is an economic term used to refer to the phenomenon of firms being located close to one another.
There are a number of components we’ll explore later in this lesson, but for now just remember that agglomeration relates to clusters of population or business activity.
Agglomeration Theory and Process
At its core, agglomeration’s underlying theory is that businesses and resources can take advantage of a number of efficiencies by being located close to one another. There are actually two major categories of agglomeration: Urbanization economies and Localization economies.The term urbanization economies refers to benefits that firms in a number of different industries receive from population and infrastructure clusters. A great example of this is a shopping mall. Although the stores in the mall may be unrelated, locating close together gives them the opportunity to use the same infrastructure: building, parking lots, and other common areas. Another urbanization benefit in this example is that stores have the opportunity to market and sell to customers who go to the mall to visit another store.
Localization economies, by contrast, are those in which firms in the same industry get benefits from being located close together. The major benefits of localization include the ability to draw from the same skilled group of workers, known as labor pooling, and quicker spread of ideas among firms within the same industry, a concept known as knowledge spillovers. Localization economies are powerful–think of our Detroit example earlier. Access to skilled labor specific to the auto industry, common suppliers, and the potential for knowledge spillovers were powerful factors in turning the city into an auto manufacturing hub.
It’s important to note that the benefits of agglomeration do not always outweigh the costs. Clusters of people and firms can have negative effects, such as pollution, increased competition among firms, and traffic congestion. These diseconomies of scale provide a tension that counterbalances the incentive to cluster. Diseconomies of scale limit the growth of cities, because if they outweigh the benefits a company will receive by agglomerating, the company will not join the city cluster.
We’ve seen that agglomeration has led to the development of shopping malls and industry hubs like Detroit, but what other practical effects has agglomeration had on society? In fact, agglomeration is so powerful that it is the underlying reason cities were formed and continue to exist today. Think about it this way: if a company is located by itself in the middle of nowhere, it would likely have no workers to hire close by, no customers in the vicinity, and the company would have to pay to develop infrastructure like roads and electricity on its own. That would be expensive and highly inefficient.
Now imagine that ten or twenty companies locate in the same area. There will be more people in the area, so there is a larger labor pool for companies to hire from. Likewise, those same people will increase the customer base for each firm. Lastly, companies can share the cost of building roads, power lines, and other infrastructure.
This incentive to cluster was the key driver in the development of cities. Although a city’s growth is still limited by the diseconomies of scale we discussed earlier, the continuing benefits of agglomeration still shape our urban areas.
You can see now that Detroit becoming America’s auto capital wasn’t a matter of coincidence but rather the result of a powerful force we call agglomeration, which is an economic term used to refer to the phenomenon of firms being located close to one another. The benefits that firms, whether in the same or different industries, receive from clustering together and having access to common labor, infrastructure, and customer bases were the basis for the creation of cities and continue to influence urban development.