New Economic Geography

NewEconomic Geography

Integrationof two or more countries may give rise to a concern pertaining to theeconomic effects of the new integration on the countries involved. Inreference to the traditional trade theory, occurrence of economicliberalization between two countries creates a benefit to each ofthem due to comparative advantage. However, the two countries do notbenefit in the same magnitude. This situation results in increasedlevels of consumption in every country, which arises from increasedtrade activities as judged against autarchy.1The idea of economic integration induces the aspect of trade betweenthe countries involved. Alongside trade, it incorporates severalrelevant elements for special development and economic geography. Inrecent years, the elements have been examined in depth and theresults reveal that economic integration coupled with internationaltrade theory have a strong and unfailing connection with locationissues.2

NewEconomic Geography

Theneed to assess the extent that trade liberalization impacts ongeographical circulation of the industries and increasedagglomeration of firms in some areas as a result of deeper economicintegration have led to the rise of the (NEG).Thus, the is the body of research that isrooted from the international trade theory that explains the reasonbehind the formation of economic agglomerations in certaingeographical areas.3NEG employs some tools and concepts and some indefinite influence oneconomic integration that were used before its emergence. Forexample, the concept of ‘cumulative causation’ was discussed byMyrdal (1957). This concept emphasizes that the occurrence ofagglomeration is steered by the escalating returns to scale. Theessence of externalities for localization was explored by Marshall(1970) and the prediction of the detrimental impact of economicintegration on less developed regions.4

WhatConstitutes the ?


Increasingreturns to scale is a crucial concept in accounting for spatialinequality caused by economic activity, taking into account thegeographical effect as a fundamental component in the analysis. NEGmodels permit the occurrence of increasing returns. The manufacturingfirms are lobbying to increase their scope of production so as totake advantage of the growing economic ties. Therefore, increasingreturns presents famous incentive to the production firms toconcentrate their production activities in a given geographical areainstead of spreading them over different geographical regions. Thisidea benefits the firms in terms of lower production costs arisingfrom the creation of larger firms. According to Ascani et al5,increasing returns fundamentally constitutes a leitmotivofNEG that he claims to be at the center of explaining the specialdifferences arising from the allotment of productive activities.6However, the simple presence of increasing returns does not warrantthe automatic concentration of production space. The impact ofagglomeration as a result of increasing returns is a complicatedoutcome of the interaction between other economic forces.


NEGincludes transport costs as an important element that influences thechoice of location of a firm. In the traditional trade theory,transport costs are assumed to be zero.7NEG adopts a form of “iceberg transport costs,” where apercentage value of the quantities of the shipped products arriveswhen moving the produce from one place to another and the rest is metas the shipment cost. Thus, the influence of transport costs on thelocation of the firm is dependent on the value of the cost. As aresult, firms face the decision of whether to concentrate in onelocation and export the produce to other regions, or whether to bearfurther fixed costs in putting up a new industry in at anotherlocation. The firms will consider the more convenient undertaking.Thus, the integration between increasing returns and transport costsconstitutes an important force towards an agglomeration or spatialityin the behavior of firm’s location.


Monopolisticcompetition emphasizes the presence of the economies of scale in theformal models. Inclusion of scale economies points that thecompetition between the production firms is not nearly perfectbecause firms have the ability to increase their production and atthe same time reducing the cost per unit of output.8Conversely, it is difficult for a firm to increase production inperfectly competitive markets without making negative profits,therefore, the concept of increasing returns to the firm internally,may not apply. However, the reality of increasing returns enables thefirms to create bigger plants, which are more efficient than thesmaller scattered firms.

Whena firm concentrates in one location, it attracts the economies ofscale, which gives it a higher competitive advantage over smallerspatially scattered firms. On the contrary, the frequent decreasingreturn in the perfectly competitive markets erodes the incidence ofeconomies of scale that may accrue to the firm internally. In thissituation, firms may show little concern in choosing the locationsince they are deprived of the benefit of increasing returns. Thus,the firms choose to locate to any place where there is a market fortheir commodities. Thus, imperfect competition proves better inrelation to the economies of scale and the impact of spatial patternin location of firms.

Monopolisticcompetition is characterized by horizontally differentiated products.These products have constant elasticity of substitution (CES), suchthat the consumer can purchase small quantities of each variety ofthe commodity. Thus, every firm that will operate under increasingreturns will produce only one variety of a differentiated commodity,which the firm can decide on its price.9Consequently, every firm operates monopolistically in a given market,in relation to its variety of productions. The market size is limitedto the existence of substitute varieties, which can be determined bythe level of entry of other firms in the similar line of production.Entry of other firms restricts the monopolistic control in terms ofprice. Thus, just like perfect completion, such monopolisticstructure may have various producers and freedom of entry and exit.NEG adopts this arrangement trace the market and demand makeup whileaddressing increasing returns. This structure provides a theoreticalframework that allows the investigation on the impact of formingeconomic agglomeration in space.


Inclusionof external economies in NEG helps to account for the heightenedlocalization of industries. The concept puts into account thepresence of specialized intermediates, labor market pooling and theeffects of technological spillovers.10Firms that are located in a single region enjoy the pooled laborforce, in terms of adequacy and quality. Concentration of firms isadvantageous to the workers because there is reduced risk ofunemployment. The efficiency is improved as a result of agglomerationof industries. In addition, when firms concentrate in one area, theytake advantage of the specialized suppliers of the both inputs andintermediate goods. Thus, agglomeration creates both forward andbackward links involving the producers and the suppliers, which inturn contributes to self-reinforcing efficiency within the industry.

TheCore-Periphery Model

Krugman&amp Venables11presented this first model for to explain the functioning of NEG inprediction of the influence of agglomeration in the face of economicintegration. The model comprises two regions and two sectors: themanufacturing and the agricultural sectors that are concentrated inone area. The manufacturers use labor, as their only input, toproduce a continuous variety of differentiated products. Differentfirms produce a different variety of products under scale economies.12The agricultural sector produces undifferentiated products and theyuse farmers as the only input. Workers have freely mobility and cantraverse from one region to another. Farmers are permanent, but areequally distributed between the regions. The farmers produce istraded between the regions without added costs while themanufacturers produce bear the transportation costs.

Thismodel emphasizes on a centrifugal force that holds the farmers due totheir immobility. This centrifugal force is stronger and involvescircular causation. The location of large firms in one region leadsto production of varieties. Workers in that region gain access to avariety, which in turn raises their real incomes, making workers fromother regions to migrate to this region.13In addition, the resulting increase in the number of workers, who arealso the consumers, creates a bigger market compared to the otherregion. This scenario is equivalent to the ‘home market effect,’which is a familiar concept in international trade. The economies ofscale present an incentive to concentrate the production of a givenvariety in a single region. Owing to the transport costs, it is moreefficient to produce from a single region that offers a bigger marketand then ship the produce to other markets.14

Theincreasing returns in the manufacturing sector, which is imperfectlycompetitive makes the industries to concentrate their manufacturingin selected regions. The two countries experience unequal entrance tothe market. The larger (core) country benefits from its centrallocation and better market access, while the smaller (peripheral)country inhabits only a peripheral location with very limited accessto market demand. This arrangement makes a great influence on thefirms’ location. The core country attracts the location of severalfirms, which in turn creates agglomeration forces. The firms are ableto access a large pool of customers without bearing the shipmentcosts. Also, it enables the firms to serve the periphery in the formof exports. Industries in the core country can raise exports to theperiphery and avoid the diffusion competition effects in the core.Thus, this model enables the firms to relocate to the core and servethe consumers in the periphery through exports.


NewEconomic Geography emerges from the concept of economic integration.It emphasizes on the advantages of agglomeration as opposed tospecial economies. NEG is driven by the concept of increasingreturns. NEG deviates from the classical trade theory that assumedtransport costs are negligible. NEG presents a trade-off between thechoices that face the firms. Firms have to decide on whether toproduce from a delocalized place and transport the produce or whetherto produce from a single location and transport the produce to theperiphery. It is evident that production from one location hasseveral advantages to the producers, the consumers and the suppliers.Firms can get a constant supply of quality labor and productioninputs while consumers enjoy a variety of products at affordablecosts, hence increasing their real incomes. Theincreasing returns associated with agglomeration presents a famousincentive to the production firms to concentrate their productionactivities in a given geographical area instead of spreading themover different geographical regions.


Andrea,Ascani. “ and economic Integration: A Review.London: London school of Economics and Law. 2012: 1-19.

Fujita,Masahisa, &amp Krugman, Paul. “The : Past,present and the future.” Papersin Regional Science 83,(2004):139-164.

Krugman, P. and Venables,Anthony, J. “Integration, specialization, and adjustment.”European EconomicReview, 40,(1996): 959-967.

Schmutzler,Armin. “The new economic Geography.” Journal of economic Surveys13, 4 (1999): 355-374.

1 Andrea, Ascani, Ricardo, Crescenzi and Simona Lamarino. “New Economic Geography and economic Integration: A Review. London: London school of Economics and Law. 2012: 2.

2 Ibid., 2

3 Fujita &amp Krugman. “The : Past, present and the future.”

Papers in Regional Science 83 (1), 2004: 142.

4 Ascani et al. and Economic Integration. 2012: 2

5 Ibid., 3.

6 Ibid., 3.

7 Ibid., 4.

8 Armin, Schmutzler. “The new economic Geography.” Journal of economic Surveys 13, 4 (1999): 360.

9 Ascani et al. and Economic Integration. 2012: 4.

10 Ibid., 5.

11 Paul, Krugman, and Anthony, Venables , 1996. Integration, specialization, and adjustment. European Economic Review 40. 1996: 963.

12 Fujita &amp Krugman. “The : Past, present and the future.”

Papers in Regional Science 83 (1), 2004: 145.

13 Armin, Schmutzler. “The new economic Geography.” Journal of economic Surveys 13, 4 (1999): 360.

14 Ibid., 360.