Agglomeration economies or external economies of scale refer to the benefits from concentrating output and housing in particular areas.
If an area specialises in the production of a certain type of good, all firms can benefit from various factors such as:
- Good supply networks
- Supply of trained workers
- Infrastructure built specifically for the industry
- Good transport links.
Due to agglomeration economies, people and firms often concentrate in particular areas. For example, people tend to move to cities where is there is a greater choice of jobs, social activities and specialist services
However, there is always the risk of dis-economies of scale, where firms become too big and average costs start to rise.
Examples of agglomeration economies
Silicon Valley. IT setups tend to cluster in similar regions, such as Silicon Valley California, and major cities, like London. The reason is that these areas attract highly skilled IT personnel and it is easier to recruit the right staff. Also, the support infrastructure will surround the areas. There will be a competitive market for designers, software engineers, and proofreaders.
West Midlands car industry. In the UK, the West Midlands around Birmingham became an important hub for car production in the UK. Around this area developed good transport links and firms servicing the industry with spare parts.
Chinese clothing manufacturers. China has seen a strong growth in manufacturing industries on the south-east coast. These areas have good transport links for exporting to the rest of the world. Also, the areas have attracted migrant flows from northern China, enabling wage costs to remain low.
Importance of agglomeration economies
- Small initial differences may lead to industries setting up in particular industries, which means other firms want to set up in the same location
- If industry is concentrated in a particular region, then industrial decline can become more problematic.