Economies of Agglomeration

The term economies of agglomeration is used in urban economics to describe the benefits that firms obtain when locating near each other ('agglomerating'). This concept relates to the idea of economies of scale and network effects. Simply put, as more firms in related industries cluster together, costs of production may decline significantly (firms have competing multiple suppliers, greater specialization and division of labor result). Even when multiple firms in the same sector (competitors) cluster, there may be advantages because that cluster attracts more suppliers and customers than a single firm could alone. Cities form and grow to exploit economies of agglomeration.

Diseconomies of agglomeration refers to the opposite case. Additional competition drives down pricing power. Growth with automobile-oriented development patterns may create problems of crowding and traffic congestion. It is this tension between economies and diseconomies that allows cities to grow, but keeps them from becoming too large.

Agglomeration economies are most closely associated with economies of scale and these network effects as stated above. It is important to understand the possible ultimate outcome of agglomeration economies, only if the benefits outweigh the disadvantages. The ultimate end to agglomeration economies is the formation and growth of a city. However, there are processes involved and factors that must contribute to the formation and growth of cities. These are considered here in the types of economies that are formed, their sources that are the contributing factor, network linkages, and the advantages and disadvantages that may or may not occur in the growth and formation of cities.

In simple terms, the basic concept of Agglomeration Economies is that production is facilitated when there is a clustering of economic activity. Although this may be true, the reality of it is that the existence of agglomeration economies is central to the explanation of how cities increase in size and population; which places this phenomenon on a larger scale. This concentration of economic activity in cities is the reason for the existence of them and they can persist and grow throughout time, only if their advantages outweigh the disadvantages. It is significant to understand why these advantages allow for the persistence of cities.