Location Theory Definition in Economics

Location theory is a stream of economic thought that incorporates geographic location as one of the variables that determine the market balance.

The objective of location theory is to study how space plays a key role in the decisions of producers and consumers. This is due to the fact that the supply of a merchandise and its demand can be found at distant points, which generates costs (such as those corresponding to the freight of the transport).

Characteristics of Location Theory

Between the characteristics of the theory of the location they emphasize:

  • They not only analyze the impact of transport costs, but also the opportunity costs for the transfer time.
  • We can understand the above with an example. Imagine that a person must travel half an hour to get to the supermarket of their choice. Those thirty minutes could be used for a productive activity or, in any case, for a leisure activity that would generate satisfaction.
  • The price of a good may vary, depending on its location, by having to incorporate the cost of your transfer.
  • When the product must be transported, indirect communication and information costs are generated that are part of the logistics administration. In this way, it is monitored that the merchandise arrives at its destination in the appropriate conditions.
  • In some cases, it is the consumer who moves to acquire the good or service.
  • The rational thing is that consumers and producers seek to reduce transport costs when making their decisions. That is, a company will consider the distance from its customers, for example, as a decision variable when choosing where to build its new factory.
  • As transport costs have been decreasing in recent decades, thanks to technological development, de-concentration of production has been possible. In the mid-twentieth century, it would probably not have been profitable for a firm to manufacture its merchandise on one continent to sell them on another.

Theory of Location and Agglomeration Costs

Location theory is related to the agglomeration economies. This concept refers to the benefits that companies obtain when they are located near each other, being able to be suppliers and customers.

Likewise, agglomeration economies also refer to the utility it generates for a company to be close to the final consumer. This, due to the savings in distribution costs.