Competition theory
L ocation and residence

Competition increases welfare by ensuring that prices equal marginal production costs and hence that goods are consumed whenever consumers are willing to pay more than the marginal cost of supply. Firms will not behave like perfect competitors if each one is large relative to its market, however, and most models of firm location assume that firms have fixed costs and play a two- stage game of choosing their locations and then competing on price, recognizing that consumers will shop at the firm where the unit price plus transport cost is smallest. Despite entry, firms retain local market power and can charge high prices, so there will be more firms in equilibrium than are justified by reduced transport costs. Prices will exceed marginal cost, there may be too many firms, and they may not locate optimally.

In Discussion Paper No. 724, Suzanne Scotchmer and Research Fellow Jacques-François Thisse note that the literature on local public goods, in which allocation mechanisms lead to efficiency, contradicts these results. Location models have `location without land', while local public goods models have `land without location'. In the former, consumers have fixed locations and do not pay for the land they occupy, so they have no opportunity for capitalization. In local public goods models, however, a resident must occupy land in a jurisdiction in order to enjoy its public goods, which are capitalized in the land price; residents of neighbouring jurisdictions are excluded even if they can easily bear the transport costs. These conclusions are essential for capitalization incentives to induce the efficient provision of local public goods and an efficient distribution of population. Scotchmer and Thisse investigate whether similar arguments can be adapted to model the location and price decisions of firms providing private goods and find that such mechanisms may work, but they are outside the framework of the `competitive model'.

The Implications of Space for Competition
Suzanne Scotchmer and Jacques-François Thisse

Discussion Paper No. 724, October 1992 (AM)