1. Economic Base Theory
Economies of Scale
Economic Cycles

2. Questions are taken from the visible PowerPoint slides.
Quiz #2 March 1st, on lectures 4 (Financial system) and 5 (Cycles, EBT, Scale).
Study the PowerPoint and use the Study Guide that will be on the website.
Questions are taken from the visible PowerPoint slides.
More detail is on the hidden slides or slide notes but no questions are taken from them.
Data questions: No specifics required unless I say so in lecture but you need to know ‘greater than, increase/decrease’ type answers.
Date questions: I give you dates/periods and you have to know what went on.

3. Topic List
Economic Cycles: Kondratiev Schumpeter Mensch Inventory Product Product Cycle Consumer groups Inventory Cycle Peaks, Troughs, Lags Keynes Economic Base Theory Comparative Cost Advantage Circular and Cumulative Causation Scale Economies Internal and External
Another aspect of the evolution of the spatial economic system is the idea than history is marked by periods of prosperity and periods of decline.
While these have been labeled as booms and busts in the vernacular, a more detailed analysis shows that the transitions are marked by distinct cyclical periodicity.
We are going to explore four types of economic periodicity that have been identified:

4. Booms and Busts
Economic systems are punctuated by periods of prosperity and periods of decline. In the vernacular, they are labeled as booms and busts and have distinct cyclical periodicity. We are going to explore five types of economic periodicity that have been identified, and the reasons for them: Kondratieff Cycle Schumpeter’s Innovation-Invention Cycle Mensch’s Metamorphosis Cycle Inventory Cycle Product Cycle And one macroeconomic model of how to regulate it all – the fiscal theory of the Keynes Model.
Another aspect of the evolution of the spatial economic system is the idea than history is marked by periods of prosperity and periods of decline.
While these have been labeled as booms and busts in the vernacular, a more detailed analysis shows that the transitions are marked by distinct cyclical periodicity.
We are going to explore four types of economic periodicity that have been identified:

5. CYCLES

6. Economic Cycles
Early in the 20th century, macroeconomic theory postulated that the supply and demand processes that drove economic patterns were cyclical and of various lengths and durations.
These cycles created peaks and troughs, and lags in supply and demand, and influenced economies accordingly.
When the various peaks and troughs of the different cycles coincided patterns of growth and decline in prosperity got intense, and when they didn’t (i.e. when the lags created unsynchronized patterns) the intensities weakened in strength and duration.
Various policy tools were developed to predict and mitigate the excesses of these synchronized and unsynchronized patterns, but they worked with varying success, and one of the first and most successful was Keynes’ General Theory.1
1: John Maynard Keynes. The General Theory of Employment, Interest, and Money (1936).

7. Economic Cycles Stumble
One of the problems that has arisen across the 100 years since these patterns were discovered is that their lengths and durations have changed, usually by shortening in length and speeding up in duration. This has caused the policy tools that were developed to manage economies to become less effective and even damaging as the mechanisms of cause and effect begin to “stumble” into the next cause and effect, usually exacerbating rather than mitigating the excesses. This is most noticeable in the “stagflation” of the 1970s as Keynesian fiscal policy drove economies into inflation and unemployment – hitherto mutually exclusive macroeconomic attributes.

8. Economic Cycles - Models
The Kondratieff (or long wave) Cycle. Forty to sixty year cycle. Schumpeter’s Innovation-Invention cycle. Mensch’s causal mechanism. The Inventory Cycle. Four year cycle. Relationship between supply & demand, and inventory to sales (or turnover) ratios. The Product Cycle. Based on process of bringing products to market (innovation) – or purposely stalling it. The Keynesian Cycle. Less a cycle and more a macro-economic system theory.

9. Kondratieff W a v e s

10. The Kondratieff Long Wave (a.k.a. K-Waves, super-cycles)
Russian economist Nicolai Kondratieff postulated in 1925 that industrial nations experienced successive cycles of growth and decline of about fifty years periodicity.
Industrial revolutions not smooth but comprised of:
A succession of innovations.
Occurring at roughly fifty year intervals.
Punctuated by major economic recessions.
Long waves were characterised by the collapse of the former growth industries that:
Had overshot needs and were overbuilt.
Were overprotective.
Were hostile to innovations that threatened their status quo.
5. INDUSTRIAL HISTORY: ECONOMIC WAVES AND CYCLES.
1. Introduction:
The idea that economic phenomena might be cyclical in nature was first formalised in the 1930s by Joseph Schumpeter, who suggested that economic cycles were evident.
He suggested that they could range from the seasonal ups and downs of retail trade and its effects through backwards linkages to the production sector, to the four year inventory cycle, to the long waves of economic development first proposed by Nicolas Kondratieff.
Apart from these different types of economic cycles, there are also evident cyclical processes related to the development. production, marketing and stagnation phases of a product (the product cycle), and to the production cycle itself.
The purpose of this section is to look at some of these different types of economic cycles or waves and their effects on manufacturing.
2. Long Waves in Economic Evolution:
The Kondratieff Waves:
The industrial revolution was an historical event in which a world comprised of largely self sustaining agrarian societies was transformed into a progressively more interdependent global economy.
But the industrial revolution was neither gradual nor continuous; it was comprised of
- a succession of innovations,
- occurring at roughly fifty year intervals,
- punctuated by major economic depressions
in which there was a collapse of the former growth industries that had overshot needs and were overbuilt, overprotective, and hostile to innovations which might threaten the status quo in which they were the dominant activities.
In the 1920s a Russian economist, Nicolai Kondratieff, postulated that the industrial nations of the world, when looked at collectively, had experienced successive cycles of growth and decline since the beginning of the industrial revolution. The cycle length was about fifty years.
Kondratieff ended up in the Gulag for his troubles - after all, Marx had said that capitalist countries sowed the seeds of their own destruction and hence to suggest that they could or might rise from the ashes was a no-no.
Kuznets Periods:
Again in the 1920s, Simon Kuznets undertook painstaking statistical research on the long wave phenomena, and he suggested that three long waves had occurred by the 1920s, and that each wave was accompanied by periods of prosperity, recession, depression, and recovery.
[OH:TABLE 11.2, LONG WAVES, BERRY 279]
[OH:FIG 3.4, WHOLESALE INDEX/WAVES AGNEW]
Schumpeter's Inventions and Innovations:
In the 1930s Schumpeter took Kondratieff's ideas and Kuznets' empirical work, and pointed out that his cycles seemed to coincide with bursts of innovation in technology, preceded by stretches of invention accumulation.
Accompanying each cycle or epoch were new technologies based on the build up of inventions which became applied as innovations:
[OH:FIGURE 11.1a,b,c,d, BERRY p280]
Note in panels b and c of the figure, the transportation innovations of:
- industrial water power and inland water transportation (the sail/wagon epoch of Borchert's model of American metropolitan evolution - see Yeates and Garner); these tend to fix industry to specific sites;
- coal --> steam --> railroads; these tend to loosen the spatial constraints on industry such that they now cluster in urban areas under the influence of external scale economies (see Economies of Scale notes this volume);
- petroleum --> autos --> roads; these tend to make industry footloose and to decentralise it from city cores to peripheral locations.
In each instance the peak of development of the innovation preceded a major economic collapse.
Mensch Metamorphosis Model:
Schumpeter had introduced the idea of technological revolutions as the central driving force behind the long wave phenomena, but he did not explain why the long waves existed.
Gerhard Mensch built on Schumpeter's ideas, proposing what he termed the "metamorphosis model" of long wave generation.
First he distinguished precisely between inventions and innovations:
- inventions (or scientific discoveries) occurred relatively steadily in response to societal demands and needs, and represented the basic ideas for things;
- innovation represented the practical application of the idea or invention.
What Mensch discovered was that the innovations tended to come in clusters or surges:
[OH:FIG 80,GOODALL p253, K-CYCLES & INV/INNO]
On the figure:
- a clustering in the period 1814 to 1828 of basic innovations after a long stretch of invention accumulation;
- likewise, electrotechnical and chemotechnical clustering in , and
- wartime electronic inventions see production application peaks by 1950.
Surprisingly, these periods of innovation also coincided with periods of depression and economic crisis.
Two questions emerged therefore:
1. Why do innovations cluster?
2. Why do clusters coincide with depressions?
For these answers Mensch postulated a sequence of causal steps that he called his metamorphosis model:
^ stagnation |
| saturation
growth in
investment, depression
prosperity, accelerated
sales growth
| rapid
| upswing recycle
| initial
| entry
| >
TIME about 50 years
The characteristics and causal processes for each stage in the model are as follows:
Initial Entry Stage:
- income, employment, economic well being increases faster than inflation and prices;
- high levels of useful capital available;
- venture capital dominant;
- industrial location at research parks.
Rapid Upswing and Accelerated Growth Stages:
- rationalisation of production;
- standardisation of products;
- emphasis switches to cost reduction;
- maximisation of scale economies;
- shift from better products to better prices as competitive weapon;
- erosion of purchasing power, and inflation;
- location shift to offshore or sunbelt (cheap labour) areas - industrial restructuring begins.
Saturation Stage:
- income growth slows, unemployment increases and credit/savings buying increases;
- corporate growth overestimates domestic markets leading to oversupply of industrial capacity leading to under-utilisation and hence more expensive unit production costs;
- attempts are made to reduce competition through mergers, market segmentation, product segmentation (image, packaging, etc. or 'pseudo-innovation');
- investment flows are to capital markets and other paper investment rather than to the industrial sector, leading to decline in R&D investment and over-valued stocks;
- as companies merge, oligopolies develop to control both price and output leading to stagflation;
- these large companies suffer from the dinosaur effect: in an attempt to maintain the status quo which favours them they reduce the innovation (R&D, investment) necessary for the growth which keeps the economy and themselves healthy.
Stagnation and Depression:
- technological stalemate as status quo replaces growth, and innovation decreases, and the rise of conservatism and low risk managers occurs;
- slow growth leads to recession and decline in stock prices leading to undervalued production structure;
- deindustrialization, industrial restructuring and rationalisation takes place leading to selective closures based on profitability;
Recycle Stage:
- excessive paper capital becomes venture capital as it reinvests in undervalued stocks;
- new injections of capital initiate burst of innovations based on the backlog of inventions unable to find backing in the previous conservative status quo years and new plants develop.
In conclusion, the Mensch model has two important elements:
1. An industrial/economic trigger wherein stagnation reduces the usefulness and profitability of labour and capital in overgrown traditional industries, leading to the implementation of cost-saving and productivity adding innovations.
2. Labour is displaced and socio-political conflict increases as a variety of groups seek to change the system and re-establish stability.
The Five Kondratieff Waves:
[OH:FIG 5.9,LONG WAVE MAJOR FEATURES]
It is postulated that since the industrial revolution began that there have been five long or Kondratieff waves or periods in western capitalist countries.
Associated with each of these waves/periods have been a series of fundamental structural changes in the industrial economies of these nations.
3. Other Cycles Affecting Industrial Development:
There are several other apparent `cycles' that affect industrial development, ranging from the seasonal retail sales cycle to the Kondratieff.
In this section we shall look at three of these: (1) the inventory cycle; (2) the product cycle; (3) the Keynesian cycle.
1. The Inventory Cycle:
The inventory cycle has a four year period and, in its simplest interpretation, has at its heart the relationship between inventory, production and demand for products, competition, and investment.
The cycle is comprised of two phases, the growth and decline phases, each roughly two years in duration.
The phases involve a complex series of cause and effect relationships between demand for products, production and inventories of products, competition for market share and subsequent market saturation, oversupply, underutilisation of productive capacity and, finally, investment in undervalued stock which starts the cycle over again:
GROWTH PHASE
growth creates
demand
which itself inventory increases
creates demand to cope with growing
production increases
to supply inventory
increased competition
leads to oversupply &
market saturation
DECLINE PHASE
sales decrease
inventory increases
imbalance occurs
demand investment in
decreases inventory
first increases
then decreases
production decreases
as growth decreases
and inventory is used
and not replaced
under-utilisation investment in bleeding off of
of production undervalued capital to carry
capacity leads to stock inventory leads to
declining stock declining dividends
prices and stock prices
growth in company
and jobs leads to
growth in demand
and the cycle starts
again
The Product Cycle:
It behooves us to understand the product cycle because:
- it has connections to the Kondratieff cycles insofar as a product cycle is required to transform an invention into an innovation.
- it has geographical implications insofar as different stages of the product cycle have different locational requirements and impacts.
Traditionally the cycle is seen to have three stages, each with specific attributes:
[OH:FIG 7.3, PRODUCT CYCLE, CHAPMAN & WALKER]
Stage 1: R&D and Initial Growth:
- frequently protected by patents, monopoly develops
- frequent refinements of product
- methods are labour intensive
- novelty leads to high price; no pressure to lower costs
Stage 2: Maturity:
- high growth mass consumption product
- end of patent security
- competition increases
- search for standardisation and cost reduction
Stage 3: Decline:
- market saturation
- product obsolescence
- decline in sales
- production capacity reduced
The links to the Kondratieff waves are fairly self evident; the clusters of innovations each generate their own product cycles of varying length and complexity - for example the innovation might be the microchip which then stimulates a range of products and cycles of its own.
The links to the inventory cycle are also self evident; the product cycles themselves generate investment, jobs, demand, competition, saturation, stagnation and eventual decline, and perhaps depression or recession - which fits into the long waves again by punctuating the various waves.
The geographic dimensions of the product cycle are related to the changing importance of different factors of production required at various stages of the cycles, and their related costs.
Generally speaking, the stages of the production cycle can be related to specific types of manufacturing and their locational attributes:
Stage 1: R&D, Initial Growth:
* Home based; use of existing facilities as products are test marketed. Original technology.
Stage 2: Mass Production:
* Search for cost reduction and standardisation, especially in labour costs, leads to offshore plants, or sunbelt relocation. Exported technology.
Stage 3: Competition:
* Decline of production at home base as competition takes over and resources are redirected to new product lines.
* Development of other companies in other nations as products get marketed abroad. Adopted technology.
Finally there is the question of the `part process'; that is, the division of the production process such that different plants produce one component (engine blocks) of a single product (an automobile).
This can be done:
* as part of a single firm (such as Volvo factories producing the various bits of a Volvo auto);
* as several independent firms making auto parts (e.g. AC Delco, Tridon);
* located in different nations.
[OH:FIG 7.4, FORD IN EUROPE, CHAPMAN/WALKER]
Often this `part process' structure depends on production factor requirements; for example, labour requirements:
* electronics: Hewlett Packard make semi conductors in Scotland (skilled labour due to higher education standards), and assemble products in South East Asia (lower educational requirements, and about one twentieth the labour costs).
* Ford, G.M., Fiat, have all strived to relocate their plants away from labour union intensive areas to:
- dual source in order to circumvent strikes (e.g. Ford increased its share of the U.K. auto market despite strikes in the U.K., by importing Spanish and West German made Ford autos).
- Weaken auto unions (e.g. Fiat decentralised from union strong Northern Italy to the Metzogiorno (central Italy); despite lost economies of scale they lowered unit costs through lower wages, increased output through fewer strikes, and severely weakened the Italian auto workers union).
The Keynesian Cycle (or Model):
The Keynesian model of how an economy works - and hence how it can be controlled - was the basic orthodoxy for many years, and is still used depending on what flavour of government a nation has.
We need to look at it very briefly because:
* it involves the complexities of demand for manufactured products, how that demand affects the national economy, and how it can be manipulated to control inflation and unemployment.
* it involves investment, and how it can be likewise manipulated for the same ends.
The model, and its associated policy tools, was especially popular in post depression USA where it appeared to work well in providing governments with a tangible way to control inflation and unemployment.
Keynes postulated that a closed economic system with no leakages or injections of money would remain stable, without inflation or unemployment.
But economies are not closed, either in time or space, and leakages/injections constantly threaten inflation and unemployment.
Keynes suggested that government, through spending or taxation could manipulate the demand side of the economy to control inflation and unemployment - music to any politician's ear.
The basic model is:
Stable, closed cycle where
| income earned = income spent |
| |
v ^
employees work, money is spent entrepreneurs
make products, >>>> on local goods >>>> produce goods
earn income, by government, to satisfy
invest and buy investors, people. demand.
AGGREGATE DEMAND
- investment to abroad - investment from abroad
- government taxes - government spending
- import purchases - export earnings
When leakages occur: When injections occur:
- spending power falls - spending power rises
- aggregate demand falls - aggregate demand rises
- factories close leading - excess money chases smaller
to UNEMPLOYMENT stock of goods, leading to
INFLATION
For Keynesians the policy options are straightforward:
* control leakage by deficit spending, taxing less, and discouraging imports.
* control injections by less government spending, more taxes, leading to balanced or surplus budget.
These options are known as Fiscal policy.
4. Concluding Points:
All of the cycles outlined here affect factories;
* locationally, by the nature of the products being made, their respective need for factors of production, and their stage of development;
* aspatially, by the nature of changing demand and investment patterns.
All cycles affect one another:
* close connections between the inventory cycle and the Keynesian model through the effects of fiscal policy on demand and investment;
* linkages between the Kondratieff cycles and the production cycle through the transformation of accumulated inventions to clusters of innovations;
* relationships between the production cycle and the inventory cycle through the operation of demand, investment, and competition, which are common to both.
All cycles are simple attempts to model an economic system which is affected as much by social and cultural behaviour as it is by money and demand.
All cycles are affected by the increasing pace of decision making as the global economy integrates more and more rapidly.
[OH:FIG 8.13, INCREASING PACE, DICKEN]

11. Stock index line Wholesale Price index line 1789-1844 1845-1896
PPI = Producer Price Index
CRB = Commodity Research Bureau Index ?

12. A fifth Kondratieff? Electrification Chemicals Bio Steam Autos/Oil ?
Price
index
line
Stock
A fifth
Kondratieff?
Electrification
Chemicals
Autos/Oil
Bio
Nano
Environmental
Technology
Robotics
Steam
Technology
Autos/Oil
ITC
Rail/Steel
Technology
PPI = Producer Price Index
CRB = Commodity Research Bureau Index
ET = environmental technology
NT = nanotechnology
BT = biotechnology
2010?-2070?

13. How Do Kondratieff Waves Work?
How Do Kondratieff Waves Work?
Kondratieff Waves are well accepted in financial economic analysis but (ironically) not in mainstream economics, yet that hasn’t stopped economists from trying to figure out a process for them.
Two main causal mechanisms exist to explain them:
Schumpeter’s invention/innovation cycle.
Mensch’s metamorphosis model, based on…
… the Product Cycle, and…
… the Inventory Cycle.

14. Invention and Innovation
Schumpeter:
Invention and Innovation

15. Schumpeter’s Invention/Innovation Cycle
Schumpeter (one of the great economists) said that K-Waves coincide with long periods of invention accumulation followed by bursts of innovation.
That is, inventions are made into new and different products or innovations.
For example, the bright idea (invention) gets made into the light bulb (innovation).
These are adopted and produced, and go on to replace the previous similar innovation (e.g. gaslights).
Each peak in the K-wave coincides with these new innovations on the market.

16. Schumpeter’s Invention/Innovation Cycle
E.G. POWER SOURCES
Various types of increasingly more efficient power sources replace one another.
Coal
Water Power
Oil/Petroleum
Electrification
Spatial Constraints on Location Loosen
Percent of Peak Development
Kondratieff Periods ?

17. Schumpeter’s Invention/Innovation Cycle
E.G. TRANSPORTATION
Various types of increasingly more efficient transportation modes replace one another.
Railroads
Motor vehicles
Inland waters
Surfaced
Roads
Spatial Constraints on Location Loosen
Percent of Peak Development
Kondratieff Periods ?

18. A fifth Kondratieff? Electrification Chemicals Bio Steam Autos/Oil ?
Price
index
line
Stock
A fifth
Kondratieff?
Electrification
Chemicals
Autos/Oil
Bio
Nano
Environmental
Technology
Robotics
Steam
Technology
Autos/Oil
ITC
Rail/Steel
Technology
PPI = Producer Price Index
CRB = Commodity Research Bureau Index
ET = environmental technology
NT = nanotechnology
BT = biotechnology
2010?-2070?

19. Mensch’s Metamorphosis Model

20. Mensch’s Metamorphosis Model
Why should the invention/innovation cycle work at all?
Based on capital seeking best places to invest, which leads to…
The Product Cycle
and
The Inventory Cycle
Both of which supply these opportunities because the invention -> innovation cycle requires production and inventory.

21. Mensch’s Metamorphosis Model
Capital shifts to paper investment, companies maintain product status quo, marketing ‘innovations’ prevail, company value is based on growth, risk avoidance increases.
Capital shifts to safe assets (e.g. gold), companies contract & maintain profit though decreasing costs, bubble valuations prevail, risk avoidance high.
Other Possible Coincident Causal Mechanisms:
Demographics – Spans Two Generational Periods
War – Saturation Level Coincident With Conflicts
Capital seeks accumulated inventions to innovate into products, companies are undervalued, risk avoidance low.
Saturation
INVENTORY CYCLES
Stagnation
Growth in investment & prosperity
Acceleration
Decline
PRODUCT CYCLES
Rapid growth
Initial entry
Capital seeks accumulated inventions to innovate into products, companies are undervalued, risk avoidance low.
Inventions
<KONDRATIEFF WAVELENGTH>
Innovations
Initial entry
TIME

22. Product Cycle

23. The Product Cycle - Supply
Four stage cycle in the development and decline of a product. Length depends on the product and/or product group (e.g. T.V.s versus autos). Nested consecutive sets of product cycles typify the rapid growth, acceleration, and saturation stages of the K-Wave – the so called spring, summer and autumn stages.
Monopoly
Competition
Sales
Sales & Profits
Profits
R&D Introduction Growth Maturity Saturation

24. The Product Cycle - Demand
Four types of consumers, one each for the product market periods. Will explore this more in Diffusion lecture.
Monopoly
Competition
Sales
Early Majority
Late Majority
Early Adopters
Laggards
R&D Introduction Growth Maturity Saturation

25. Inventory Cycle

26. Has two phases – growth and decline.
The Inventory Cycle 
Has two phases – growth and decline.
Length depends on the type of product and/or product group (e.g. clothing, T.V.s, autos).
Cyclical interplay between production & inventory, demand, competition and, especially, investment.
Investment is the mechanism that starts the cycle of product growth again after product saturation due to competition stalls it.
Therefore the inventory cycle is meshed intimately with the product cycle.

27. The Inventory Cycle  Growth creates demand.
Inventory increases to cope with increased demand.
Jobs created so more demand follows.
Production increases to supply inventory.
Increased competition leads to oversupply and market saturation.
Sales decrease, production continues, inventory increases, imbalance occurs.
Jobs lost, demand decreases.
Investment in inventory increases…
then decreases.
Production decreases as growth decreases due to product saturation, inventory is used up and not replaced.
Under utilization of production capacity leads to declining stock prices.
INVESTMENT IN UNDERVALUED STOCK.
Bleeding off of capital to carry inventory leads to declining dividends and stock prices.
Investment in company leads to jobs and growth in demand starts again.

28. Peaks
Lags
Troughs

29. Peaks, Troughs and Lags Peaks: Occur when a cycle reaches its zenith.
Not always a good thing - precursor to trough.
Happen in later stages of product and inventory cycles.
Market is hot - people invest unwisely in overvalued stocks causing bubbles.

30. Peaks, Troughs and Lags Troughs: Occur when a cycle bottoms out.
Not always a bad thing – precursor to growth.
Happens in earlier stages of product and inventory cycles.
Market is cool – people invest wisely in undervalued stocks and new products.

31. Is the root of synchronization issues:
Peaks, Troughs and Lags
Lags:
Occurs when effect is slower than cause.
Occurs always, but sometimes get elongated.
Is the root of synchronization issues:
Remedies for an unwanted effect are too slow and happen too late, making cycles ‘stumble’ over one another.
Remedy for cause of one problem may exacerbate cause of another.
Good example is Keynesian model.

32. Keynes

33. John Maynard Keynes 
Keynes General Theory1 “invented” macroeconomics, providing an explanation of economic functioning involving complex interplay of the product and inventory cycles and how they affected national economies by generating peaks and troughs in aggregate demand and hence economic prosperity.
Cyclical interplay between production, inventory, demand, competition and especially investment, generated periods of inflation during peaks and unemployment during troughs.
Keynes realized that government investment and taxation could be used to control inflation or unemployment.
Model was used in the late 1930s and in the post war years providing governments with a tool for controlling unemployment and inflation.
Macroeconomic model involves complex interplay of the product and inventory cycles and how they affected national economies by generating peaks and troughs of economic growth.
Keynes said that the cyclical interplay between production, inventory, demand, competition and, especially, investment, generated periods of inflation during peaks and unemployment during troughs.
Government investment and taxation could be used to control inflation and unemployment.
Model was used in the late 1930s and in the post war years providing governments with a tool for controlling unemployment and inflation.
1: John Maynard Keynes. The General Theory of Employment, Interest, and Money (1936).

34. How The Keynesian Model Works
STABLE CLOSED SYSTEM
INCOME EARNED = INCOME SPENT
Money is spent on local goods by workers, investors, governments.
AGGREGATE DEMAND
Employees work to make products, earn and spend income.
Entrepreneurs invest and produce goods to satisfy the demand.
LEAKAGES:
Investment to abroad.
Government taxes.
Import purchases.
EFFECTS:
Spending power falls.
Aggregate demand falls.
Factories close.
RESULT:
UNEMPLOYMENT
INJECTIONS:
Investment from abroad.
Government spending.
Export earnings.
EFFECTS:
Spending power rises.
Aggregate demand rises.
Excess money but same stock of goods.
RESULT:
INFLATION
Thus when injections exceeded leakages we see inflation and when leakages exceed injections we see unemployment, so for Keynes inflation and unemployment were inversely related. You could not be high on both at once. Stagflation is this very thing however, and is caused by the increasing complexity of the leakages and injections due to the increasing complexity of the boundaries through which to leak or inject. Also the speed at which the economy reacts makes a difference; action and reaction get out of synch, with leakages and injections – and the effects from them - overlapping. That is to say, since 1975 at least, globalization has made territorial boundaries more complex whereas technical advances have made them invisible. As well, the speed of change has occurred far more rapidly. All cripple the Keynesian model, which requires sufficient lag times to separate the effects of leakages from those of injections.
UNSTABLE OPEN SYSTEM. INCOME EARNED ≠ INCOME SPENT

35. Fiscal Policy and Monetary Policy
Key to Keynesian macroeconomic model is aggregate demand - the name given to how much capital is floating around in an economy looking for things to buy.
Producing and selling stuff drives employment and prices, so…
Produce and sell too little then aggregate demand falls and you get unemployment.
Produce and sell too much then aggregate demand rises, too much money chases too few goods and you get inflation.
The two approaches to managing unemployment and inflation in an economy are called fiscal policy and monetary policy and both try to control the aggregate demand of Keynes theory.

36. Fiscal Policy and Monetary Policy
Fiscal policy tries to influence aggregate demand by controlling leakages and injections through (e.g.):
Investment in public works (puts capital in).
Raising taxes (takes capital out).
Encourage/discourage exports/imports (in and out).
Done by government departments.
Monetary policy tries to influence aggregate demand by controlling the money supply:
Decrease/increase interest rates (encourage/discourage spending).
Create/remove money supply itself (increase/decrease available capital through bond issues and purchases).
Done by a nation’s central bank.

37. This is called fiscal policy
Keynesian Model Uses Fiscal Policy To Control Economy 
STABLE CLOSED SYSTEM
INCOME EARNED = INCOME SPENT
Money is spent on local goods by other workers, investors, governments.
AGGREGATE DEMAND
Employees work to make products and earn and spend income.
Entrepreneurs invest and produce goods to satisfy demand
LEAKAGES:
Investment to abroad
Government taxes
Import purchases
EFFECTS:
Spending power falls
Aggregate demand falls
Factories close.
RESULT:
UNEMPLOYMENT
INJECTIONS:
Investment from abroad
Government spending
Export earnings
EFFECTS:
Spending power rises
Aggregate demand rises
Excess money but same stock of goods
RESULT:
INFLATION
POLICY TOOL:
Control leakages by:
More government spending.
Reducing taxes.
Control imports.
POLICY TOOL:
Control injections by:
Less government spending.
Increasing taxes.
Control exports.
Thus when injections exceeded leakages we see inflation and when leakages exceed injections we see unemployment, so for Keynes inflation and unemployment were inversely related. You could not be high on both at once. Stagflation is this very thing however, and is caused by the increasing complexity of the leakages and injections due to the increasing complexity of the boundaries through which to leak or inject. Also the speed at which the economy reacts makes a difference; action and reaction get out of synch, with leakages and injections – and the effects from them - overlapping. That is to say, since 1975 at least, globalization has made territorial boundaries more complex whereas technical advances have made them invisible. As well, the speed of change has occurred far more rapidly. All cripple the Keynesian model, which requires sufficient lag times to separate the effects of leakages from those of injections.
This is called fiscal policy

38. This is called monetary policy
Monetarists use Monetary Policy To Control Available Capital 
STABLE CLOSED SYSTEM
INCOME EARNED = INCOME SPENT
Money is spent on local goods by other workers, investors, governments.
AGGREGATE DEMAND
Employees work to make products and earn and spend income.
Entrepreneurs invest and produce goods to satisfy demand
LEAKAGES:
Investment to abroad
Government taxes
Import purchases
EFFECTS:
Spending power falls
Aggregate demand falls
Factories close.
RESULT:
UNEMPLOYMENT
INJECTIONS:
Investment from abroad
Government spending
Export earnings
EFFECTS:
Spending power rises
Aggregate demand rises
Excess money but same stock of goods
RESULT:
INFLATION
POLICY TOOL:
Control leakages by increasing money supply available through lowering interest rates, increasing money supply through bond issues..
POLICY TOOL:
Control injections by decreasing money supply available through raising interest rates, decreasing money supply through bond purchases.
Thus when injections exceeded leakages we see inflation and when leakages exceed injections we see unemployment, so for Keynes inflation and unemployment were inversely related. You could not be high on both at once. Stagflation is this very thing however, and is caused by the increasing complexity of the leakages and injections due to the increasing complexity of the boundaries through which to leak or inject. Also the speed at which the economy reacts makes a difference; action and reaction get out of synch, with leakages and injections – and the effects from them - overlapping. That is to say, since 1975 at least, globalization has made territorial boundaries more complex whereas technical advances have made them invisible. As well, the speed of change has occurred far more rapidly. All cripple the Keynesian model, which requires sufficient lag times to separate the effects of leakages from those of injections.
This is called monetary policy

39. The Keynesian Model Stumbles
Injections >Leakages=Inflation
Leakages>Injections=Unemployment
Therefore inflation and unemployment are inversely related.
They supposedly cannot happen together.
But they did, starting in the 1970s with a phenomena called stagflation.
Stagflation of 1970s occurred in large part due to the increasing complexity of leakages and injections because these began to speed up.
Thus when injections exceeded leakages we see inflation and when leakages exceed injections we see unemployment, so for Keynes inflation and unemployment were inversely related. You could not be high on both at once. Stagflation is this very thing however, and is caused by the increasing complexity of the leakages and injections due to the increasing complexity of the boundaries through which to leak or inject. Also the speed at which the economy reacts makes a difference; action and reaction get out of synch, with leakages and injections – and the effects from them - overlapping. That is to say, since 1975 at least, globalization has made territorial boundaries more complex whereas technical advances have made them invisible. As well, the speed of change has occurred far more rapidly. All cripple the Keynesian model, which requires sufficient lag times to separate the effects of leakages from those of injections.

40. The Keynesian Model Stumbles
The fiscal policy tool of the Keynesian model has one fatal flaw, if it can be called that.
The model relies on sufficient lag times to separate the effects of fiscal policy on injections and leakages and the problems they are trying to control – unemployment and inflation.
For example infrastructure spending will increase aggregate demand and reduce unemployment but only if the effect of the spending occurs quickly enough.
If it does not and the market corrects unemployment, then it has the opposite effect because it injects money at a time when the economy is getting hot and induces inflation.
The 1970s saw several factors that decreased the required lag times…
Thus when injections exceeded leakages we see inflation and when leakages exceed injections we see unemployment, so for Keynes inflation and unemployment were inversely related. You could not be high on both at once. Stagflation is this very thing however, and is caused by the increasing complexity of the leakages and injections due to the increasing complexity of the boundaries through which to leak or inject. Also the speed at which the economy reacts makes a difference; action and reaction get out of synch, with leakages and injections – and the effects from them - overlapping. That is to say, since 1975 at least, globalization has made territorial boundaries more complex whereas technical advances have made them invisible. As well, the speed of change has occurred far more rapidly. All cripple the Keynesian model, which requires sufficient lag times to separate the effects of leakages from those of injections.

41. Why The Keynesian Model Stumbled
Increasing size of financial sector and its invisible leakages and injections, along with…
IT advances and speed/volume of financial decision making, along with…
Increasing complexity and porosity of territorial and aspatial regulatory boundaries though which leakages and injections occurred.
Other complications:
Oil crisis & decline of U.S. and Euro industry and with it the loss of employment and thus demand.
Removal of the gold standard allows currencies to fluctuate, distorting imports and exports.
Cheap(er) offshore products distort supply and demand relationships, as do more complicated supply chains.
In short, aggregate demand speeds up and becomes territorially more diffuse.
Thus when injections exceeded leakages we see inflation and when leakages exceed injections we see unemployment, so for Keynes inflation and unemployment were inversely related. You could not be high on both at once. Stagflation is this very thing however, and is caused by the increasing complexity of the leakages and injections due to the increasing complexity of the boundaries through which to leak or inject. Also the speed at which the economy reacts makes a difference; action and reaction get out of synch, with leakages and injections – and the effects from them - overlapping. That is to say, since 1975 at least, globalization has made territorial boundaries more complex whereas technical advances have made them invisible. As well, the speed of change has occurred far more rapidly. All cripple the Keynesian model, which requires sufficient lag times to separate the effects of leakages from those of injections.

42. cycles all fit together…
In summary here is how
cycles all fit together…

43. Welcome to The Space Economy... …the simplified version.
STABLE CLOSED SYSTEM
INCOME EARNED = INCOME SPENT
Capital shifts to paper investment, companies maintain product status quo, marketing ‘innovations’ prevail, company value based on growth risk avoidance increases
Growth creates demand
Capital shifts to safe assets (e.g. gold), companies contract & maintain profit though decreasing costs, bubble valuations prevail, risk avoidance high
Inventory increases to cope with increased demand
Money is spent on local goods by other workers, investors, governments.
AGGREGATE DEMAND
Jobs created, more demand follows
Employees work to make products and earn and spend income.
Entrepreneurs invest and produce goods to satisfy demand
Production increases to supply inventory
Welcome to The Space Economy...
Monopoly
Monopoly
Monopoly
Competition
Competition
Competition
Increased competition leads to oversupply and market saturation
Capital seeks inventions to innovate into products, companies are undervalued, risk avoidance low
Railroads
Motor vehicles
Inland waters
Stock
index
line
Sales decrease, production continues, inventory increases, imbalance occurs
Saturation
INVENTORY CYCLES
Stagnation
INJECTIONS:
Investment from abroad
Government spending
Export earnings
EFFECTS:
Spending power rises
Aggregate demand rises
Excess money but same stock of goods
RESULT:
INFLATION
Jobs lost, demand decreases
Sales
Acceleration
Investment in inventory increases, then decreases
Surfaced
Roads
Decline
Sales & Profits
Civil War
Vietnam
Spatial Constraints Loosen
PRODUCT CYCLES
WW 1
War of 1812
Percent of Peak Development
Profits
Production decreases as growth decreases and inventory is used up up and not replaced
Early Majority
Late Majority
Price
index
line
Rapid growth
Initial entry
Kondratieff Periods
Capital seeks accumulated inventions to innovate into products, companies are undervalued, risk avoidance low
Under utilization of production capacity leads to declining stock prices
Inventions
Early Adopters
INVESTMENT IN UNDERVALUED STOCK
<KONDRATIEFF WAVELENGTH>
Bleeding off of capital to carry inventory leads to declining dividends and stock prices
Laggards
…the simplified version.
Cost
Innovations
Revenue
Profit
WW 2 ?
Initial entry ?
TIME

44. Economic Base Theory

45. Or how places, regions, and nations earn a living.

46. This is called comparative cost advantage.
Economic Base Theory 
The basis of economic base theory (aka export base theory) is the market hypothesis:
"An area's growth rate depends on the export demand for goods and services in which the area has a delivered cost advantage."
In other words, an area (city, region, nation) must trade to survive, and it trades in those goods that it can produce relatively cheaper than other places.
This is called comparative cost advantage.
And it is the heart of spatial market economics.
Economics Warning!!!

47. Comparative Cost Advantage
This is a very important economic concept to understand about spatial markets and especially trade economics.
Comparative cost advantage does not mean that a nation/region has to produce goods more cheaply in absolute terms than other nations/regions.
It means that you can produce goods more cheaply in relative terms than your competitors can and still trade.
In fact, and here’s the subtle part:
you will trade even if you are better (less expensive) at everything than your competitor, and they can trade even if they are worse (more expensive) at everything than you!
Why? It pays to produce and trade in what you’re cheapest at, not simply what you’re cheap at.

48. Comparative Cost Advantage
It all has to do with the opportunity cost of producing (or in this case not producing) different goods.
That is, even if you are better than everyone else at producing two items, you may be much better at producing one of those things.
This means that you would be better served by producing more of the thing you can produce more profitably, than by producing both things.
By analogy, there are neurosurgeons who may be excellent typists. But it would not make much economic sense for a neurosurgeon to work at being a typist.

49. Example Of Comparative Cost Advantage
Units of input needed to produce 100 cars
Units of input needed to produce 1,000 computers
Canada
2 units of input
(50 cars for each unit of input)
3 units of input
(333 computers for each unit of input)
Italy
4 units of input
(25 cars for each unit of input)
(250 computers for each unit of input)
Diff per unit
Canada produces 2 times as many cars as Italy per unit of input.
Canada produces 1.33 times as many computers as Italy per unit of input.
Percent difference = ( | ΔV |/ ( ∑V/2) ) * 100 = ( | (V1 - V2) | / ((V1 + V2)/2) ) * 100
Percent Difference = (( ) / (( ) / 2)) x 100; = (25 / 37.5) x 100; = 66.66%
Percent Difference = (( ) / (( ) / 2)) x 100; = (83 / 291) x 100; = 28.52%
Canada produces both items more cheaply per unit than Italy in absolute terms but Canada is better relatively at producing cars than computers – 2 times versus 1.3 times.
Thus, if Canada used all of its inputs for cars, it would get more cars than computers, than if it used all of its inputs for computers.

50. Example Of Comparative Cost Advantage
Cost to produce 100 cars
Cost to produce 1,000 computers
Cars “lost” because you produce computers
Computers "lost” because you produce cars
Canada
2 units
(50 each)
3 units
(333 each)
150
(3 units*50)
666
(2 units*333)
Italy
4 units
(25 each)
(250 each)
100
(4 units*25)
1,000
(4 units*250)
So if Canada and Italy choose not to produce computers and redirect their resources to producing cars, Canada can produce more extra cars that Italy (150 versus 100).
And if Canada and Italy choose not to produce cars but redirect their resources to producing computers, then Italy can produce more extra computers that Canada (1,000 versus 666).

51. Comparative Cost Advantage - The Bottom Line
As can be seen from the preceding example, even though Canada is better than Italy at producing both products (computers and cars), Canada is much better at producing cars.
Canada will, therefore, produce cars and leave computers (and wine) to Italy.
In reality it is not a “none” and “all” decision; trade agreements and arrangements set quotas on how much of what gets produced where, but comparative cost advantage methodology governs these quotas.
The alternative to CCA is the winner/loser approach that inevitably leaves more losers than winners, which just as inevitably leaves many who have nothing and a few who have everything – with equally inescapable consequences.

52. Basic & Non-Basic Activities
Economic Base Theory (EBT) postulates two main parts to an economy:
The basic sector (aka the export or traded sector):
Activities in this sector earn export income for the area.
E.G. a factory.
The non-basic sector (aka the local or non-traded sector):
Activities in this sector do not earn export income for an area - they are the support activities for the basic sector.
E.G. a retail store.
Some factories and stores can be both.
There is also the household multiplier that underlies both of these.
Economic Base Theory (EBT) postulates two parts to an economy:
1. The basic sector (or the export sector): activities in this sector earn export income for the area.
2. The non-basic sector (or local sector): activities in this sector do not earn income for an area - they are the support activities for the basic sector.
EBT postulates that a relationship exists between economic activities; that is, that non-basic activities support the basic activities, while basic activities in turn support the economic health of the area.
Thus prosperity demands that an area seek and encourage the development of basic sector activities that will, in turn, stimulate the development of non-basic activities. Hence the development of an integrated economy in an area will be forthcoming.

53. Basic Activities 
In simplest terms, basic activities are income earning activities such as:
Exports: manufactured goods, export services, tourism, extra-local retail.
Investments: housing, business infrastructure e.g. offices and factories, urban infrastructure e.g. roads, etc.
Government Expenditures: government spending, current operations, transfer payments, etc.
Basic activities are considered "exogenous" in the EBT model - i.e. independently introduced and/or stimulated from outside the region/nation.
EBT postulates that a relationship exists between economic activities; that is, that non-basic activities support the basic activities, while basic activities in turn support the economic health of the area.
Thus prosperity demands that an area seek and encourage the development of basic sector activities that will, in turn, stimulate the development of non-basic activities. Hence the development of an integrated economy in an area will be forthcoming.

54. Non-Basic Activities 
In simplest terms non-basic economic activity are non- income earning support activities such as:
Locally oriented business: e.g. retail and services.
Locally oriented public sector: such as schools, police, government activities.
Government Expenditures: local government spending of local tax base, current operations.
Basic activities are considered “endogenous" in the EBT model - i.e. effects are generated by supply/demand relationships within the region/nation.
Basic question to help determine if basic or non-basic:
Would this activity survive on its own?
EBT postulates that a relationship exists between economic activities; that is, that non-basic activities support the basic activities, while basic activities in turn support the economic health of the area.
Thus prosperity demands that an area seek and encourage the development of basic sector activities that will, in turn, stimulate the development of non-basic activities. Hence the development of an integrated economy in an area will be forthcoming.

55. Wheels Within Wheels $$$$$$ Basic economy driven by external dollars.
Regional Economy
Local Economy
Wheels Within Wheels
$$$$$$
Local economy driven by the basic economy.

56. The Export Base Growth Cycle
(Circular and Cumulative Causation)
Export Income Earned
Growing basic activities generate jobs and export income
EXPORT DEMAND
Growing area attracts more basic activities.
Non-basic activities required to support basic sector.
Area infrastructure grows as prosperity grows.
Jobs and local income generated.
Household multiplier 

57. The Export Base Decline Cycle
(Circular and Cumulative Causation)
Export Income
Lost
Declining basic activities decrease jobs and export income
EXPORT DEMAND
Declining area discourages more basic activities.
Non-basic activities required to support basic sector decline.
Area infrastructure stagnates as prosperity declines.
Jobs and local income are lost.
Household multiplier 

58. Problems Of Defining Areas & Activities
 Two of the major problems in conceptualising and operationalizing EBT are:
Defining the spatial areas involved – that is, what does “outside” the region and hence exports mean?
Determining which activities or proportion of an activity are basic and which are non-basic; that is, what activities or proportions of activities are export ?
2. Problems of Defining Area and Activities.
Two of the problems in conceptualising and operationalising EBT are: (1) defining the spatial area over which it operates; and (2) determining which industries are basic and non-basic.
2.1. Influence of Area Boundaries:
Given the definitions of basic and non-basic activities, it follows that where one draws the boundary of an area will determine if an activity is an export earner or not.
For example, in the following diagram, with the boundary of the region set at A, and X is a manufacturer who sells only to consumer #1 (c1), then the manufacturer is non-basic because it does not sell (or export) its goods outside the "home" boundary of A.
However, if it also sells its goods to consumer #2 (c2), the the manufacturer is basic because it sells (or exports) its goods outside the "home" boundary of A.
Boundary B Boundary A
c2 c1 X

59. Problems Of Defining Areas and B-NB Status
Basic and non-basic proportions can be measured in terms of employment, production, sales etc. Employment is usually used.
National Boundary
Area A
Economic activity #1
Consumer #2
20%
80%
100%
Consumer #1
80%
Economic activity #1 is non-basic to Area A.
Economic activity #1 is basic & non-basic to Area A.
Economic activity #2
20%
Economic activity #1 is non-basic to national economy.
Economic activity #2 is basic to Nation B.
Nation B
Economic activity #2 is basic & non basic to Nation B.

60. Economic Sectors
Primary Sector: Resource extraction and harvesting activities, such as agriculture, mining, forestry, fisheries. Secondary Sector: Manufacturing or fabrication activities of finished and semi-finished products. Tertiary Sector: Service activities such as retail, wholesale, tourism, health care, banking, etc. However… Quaternary sector: Activities in the so-called intellectual/information sector, such as government, education, culture, information, scientific research, and… Quinary sector: Activities involving high level decision making such as business, science, education, and political/government leaders. Sometimes includes (unpaid) childcare and housekeeping activities.
2. Determination of Basic and Non-Basic Activities:
While it can be argued that any activity can be basic or non-basic depending on where the boundary of the area is drawn, traditionally certain activities or groups of activities are considered to be basic while others are considered to be non-basic.
This division of activities is based on the macro structure of the economy where three main divisions of economic activity are postulated:
i. Primary Sector: resource activities, such as agriculture, mining, lumber.
ii. Secondary Sector: manufacturing activities.
iii. Tertiary Sector: services activities such as retail, wholesale, services.
Another division, the quaternary sector, has also been developed and involves activities of the so-called information sector; newspapers, R&D, finance, engineering, and those activities that are associated with what has been termed the 'thoughtware' economy - that is, the products of the mind such as software.
Traditionally, basic activity has been considered as all of the primary and secondary sectors and none of the tertiary sector.
While this division is the one most often seen, it is more precise to think of all sectors as being more or less basic and non-basic:
BASIC NON-BASIC
P r i m a r y
S e c o n d a r y
T e r t i a r y
A recent report by the Ontario Government (see Industrial Change chapter in this volume) estimated that 80% of the `non-traded' (non-basic) industries are not income earners.
This is probably an over estimate, especially when one considers that in central place theory terms, the retail functions of the majority of small communities are income earners in the final demand sense.

61. Problems Of Defining Activities
Simple model: Primary and secondary activities are basic and all others are non-basic.
Strength:
Easily understood and easy to apply.
Weakness:
Completely unrealistic, especially in today’s globalized service based economy.
Realistic model: That all activities have some proportion of their output as both basic and non-basic.
Much more realistic.
Much more difficult to measure and apply.

62. ECONOMIC ACTIVITY CLASSIFICATION SYSTEMS
Sectors
Primary
Primary
Tertiary
Tertiary
Secondary
Tertiary
Tertiary
Tertiary
Quaternary
Quaternary

63. Industry Group ECONOMIC ACTIVITY CLASSIFICATION SYSTEMS
NAICS 2012 CLASSIFICATION STRUCTURE – SECTORS
Agriculture, forestry, fishing and hunting
Mining, quarrying, and oil and gas extraction
Utilities
Construction
Manufacturing
Wholesale trade
Retail trade
Transportation and warehousing
Information and cultural industries
Finance and insurance
Real estate and rental and leasing
Professional, scientific and technical services
Management of companies and enterprises
Administrative and support, waste management and remediation services
Educational services
Health care and social assistance
Arts, entertainment and recreation
Accommodation and food services
Other services (except public administration)
Public administration
ECONOMIC ACTIVITY CLASSIFICATION SYSTEMS
Industry Group

64. ECONOMIC ACTIVITY CLASSIFICATION SYSTEMS
31-33 Manufacturing
311 Food Manufacturing
312 Beverage and Tobacco Product Manufacturing
313 Textile Mills
314 Textile Product Mills
315 Clothing Manufacturing
316 Leather and Allied Product Manufacturing
321 Wood Product Manufacturing
322 Paper Manufacturing
323 Printing and Related Support Activities
324 Petroleum and Coal Products Manufacturing
325 Chemical Manufacturing
326 Plastics and Rubber Products Manufacturing
327 Non-Metallic Mineral Product Manufacturing
331 Primary Metal Manufacturing
332 Fabricated Metal Product Manufacturing
333 Machinery Manufacturing
334 Computer and Electronic Product Manufacturing
335 Electrical Equipment, Appliance and Component Manufacturing
336 Transportation Equipment Manufacturing
337 Furniture and Related Product Manufacturing
339 Miscellaneous Manufacturing
NAICS:
The Manufacturing Sector‘s 21 Classes
31-33 Manufacturing
311 Food Manufacturing
312 Beverage and Tobacco Product Manufacturing
313 Textile Mills
314 Textile Product Mills
315 Clothing Manufacturing
316 Leather and Allied Product Manufacturing
31-33 Manufacturing
311 Food Manufacturing
312 Beverage and Tobacco Product Manufacturing
313 Textile Mills
314 Textile Product Mills
315 Clothing Manufacturing
316 Leather and Allied Product Manufacturing
321 Wood Product Manufacturing
322 Paper Manufacturing
323 Printing and Related Support Activities
324 Petroleum and Coal Products Manufacturing
325 Chemical Manufacturing
326 Plastics and Rubber Products Manufacturing
327 Non-Metallic Mineral Product Manufacturing
331 Primary Metal Manufacturing
332 Fabricated Metal Product Manufacturing
333 Machinery Manufacturing
334 Computer and Electronic Product Manufacturing
335 Electrical Equipment, Appliance and Component Manufacturing
336 Transportation Equipment Manufacturing
337 Furniture and Related Product Manufacturing
339 Miscellaneous Manufacturing

65. ECONOMIC ACTIVITY CLASSIFICATION SYSTEMS
31-33 Manufacturing
311 Food Manufacturing
312 Beverage and Tobacco Product Manufacturing
313 Textile Mills
314 Textile Product Mills
315 Clothing Manufacturing
316 Leather and Allied Product Manufacturing
321 Wood Product Manufacturing
322 Paper Manufacturing
323 Printing and Related Support Activities
324 Petroleum and Coal Products Manufacturing
325 Chemical Manufacturing
326 Plastics and Rubber Products Manufacturing
327 Non-Metallic Mineral Product Manufacturing
331 Primary Metal Manufacturing
332 Fabricated Metal Product Manufacturing
333 Machinery Manufacturing
334 Computer and Electronic Product Manufacturing
335 Electrical Equipment, Appliance and Component Manufacturing
336 Transportation Equipment Manufacturing
337 Furniture and Related Product Manufacturing
339 Miscellaneous Manufacturing
31-33 Manufacturing
311 Food Manufacturing
312 Beverage and Tobacco Product Manufacturing
313 Textile Mills
314 Textile Product Mills
315 Clothing Manufacturing
316 Leather and Allied Product Manufacturing
NAICS Code Hierarchy for Textile Mills
to Six Digits
313 Textile Mills
3131 Fibre, Yarn and Thread Mills
31311 Fibre, Yarn and Thread Mills
Fibre, Yarn and Thread Mills
3132 Fabric Mills
Broad-Woven Fabric Mills
Broad-Woven Fabric Mills
Narrow Fabric Mills and Schiffli Machine Embroidery
Narrow Fabric Mills and Schiffli Machine Embroidery
Nonwoven Fabric Mills
Nonwoven Fabric Mills
Knit Fabric Mills
Knit Fabric Mills
3133 Textile and Fabric Finishing and Fabric Coating
31-33 Manufacturing
311 Food Manufacturing
312 Beverage and Tobacco Product Manufacturing
313 Textile Mills
314 Textile Product Mills
315 Clothing Manufacturing
316 Leather and Allied Product Manufacturing
321 Wood Product Manufacturing
322 Paper Manufacturing
323 Printing and Related Support Activities
324 Petroleum and Coal Products Manufacturing
325 Chemical Manufacturing
326 Plastics and Rubber Products Manufacturing
327 Non-Metallic Mineral Product Manufacturing
331 Primary Metal Manufacturing
332 Fabricated Metal Product Manufacturing
333 Machinery Manufacturing
334 Computer and Electronic Product Manufacturing
335 Electrical Equipment, Appliance and Component Manufacturing
336 Transportation Equipment Manufacturing
337 Furniture and Related Product Manufacturing
339 Miscellaneous Manufacturing

66. Typical Economic Base Structure
Farm
Forestry
Resources sector
Auto maker
Manufacturing
sector
Electronics
Auto Dealer
Services sector
Electronics store
LOCAL
Grocery store
EXPORTS
IMPORTS
Schools
HOUSEHOLD
University
Quaternary sector

67. Typical Economic Base Structure
Now multiply this by the thousands of factories and hundreds of thousands of stores and services and millions people in Toronto, then multiply by the thousands of large and small places in Canada, then multiply all that by the 180 or so countries that trade with Canada.
That’s the Canadian economic base upon which the national space economy is based.
Farm
Forestry
Resources sector
Auto maker
Manufacturing
sector
Electronics
Auto Dealer
Services sector
Electronics store
LOCAL
Grocery store
EXPORTS
IMPORTS
Schools
HOUSEHOLD
University
Quaternary sector

68. The Economic Base Ratio And Multiplier
EBT is linked to the overall socio-economic structure of communities by local and non-local inputs and outputs and their relative strengths. So…
When a factory that exports goods opens (or closes) not only will the factory jobs be gained (or lost), but non-basic support jobs that depended on the factory jobs will also be gained (or lost).
On the other hand, if a non-basic activity (such as a retail store) closes down, only the jobs from that store will be lost and new stores open up to collect the now freed basic income.
This relationship is conceptualised in the basic/non-basic ratio and the multiplier concept.
Should be obvious that:
EBT is linked to the overall socio-economic structure of communities in terms of local and non-local inputs and outputs, and their relative strengths.
It is obvious that the resource economy's strength lies only in its resources; most other links, such as capital, finished products, services, come in from outside the local economy, thus emphasising the dependency relationship that resource economies have with their respective core trading areas (see Core-Periphery model in the Economic Development Theory chapter of this volume).
At a more detailed level, a typical city economy is a complex interconnection of basic and non-basic activities, emphasising the problems that can arise when one element in the web shuts down and the reverberations are felt throughout the whole economy.
That is, when a factory that exports goods opens (or closes) not only will the factory jobs be lost, but the non-basic support jobs that depended on the factory jobs will also be lost.
On the other hand, if a non-basic activity (such as a retail store) closes down, only the jobs from that store will be lost.
This relationship is conceptualised in the basic/non-basic ratio and the multiplier concept.

69. The Non-Basic To Basic Ratio
 Number of non-basic jobs
Number of basic jobs
For example, if 60% of the employment in a place is non-basic, and 40% is therefore basic, the NB:B ratio is 60/40, or 1.5, meaning that there are 1.5 non-basic jobs for every basic job.
Thus, we can say that the relationship: NB = f(B) exists, and this leads us to the very important concept of the economic multiplier.
A basic conceptual indicator of the strength of the relationship between the two sectors of an economy is the basic/non-basic ratio. That is, the ratio expresses the proportional balance between the income earning and support sectors of an economy.
The ratio is expressed as:
number of non-basic jobs
number of basic jobs
For example, if 60% of the employment in a place is non-basic, and 40% is therefore basic, the B:NB ratio is 60/40, or 1.5, meaning that there are 1.5 non-basic jobs for every basic job.
Thus, we can say that NB = f(B), which leads us to the very important concept of the economic multiplier.

70. The Economic Multiplier
The multiplier postulates that changes in basic activity in an economy ripples through or multiplies its effect due to the relationship between other basic and non-basic activities. The relationship NB = f(B) generates the previously discussed NB:B ratio, with the total impact or multiplier being: M± = 1 + (NB/B) Using the previous numbers (NB = 60%, B = 40%): M± = 1 + (60/40) = 2.5 Thus, if a new factory opens (or closes) in an area, the total impact on the employment structure of the area will be 2.5 jobs: 1 new (or lost) basic job and 1.5 new (or lost) non-basic jobs.
The concept of the multiplier is a method of estimating the `ripple' effect which reverberates through an economy when changes occur in the basic sector of the economy, due to the dependency of the non-basic sector on the basic sector (the NB = f(B) idea).
Steps in the logic are:
1. EBT postulates two sectors to any economy, basic and non-basic.
2. Basic activities provide income for a region by exporting their products, and thus their fortunes are determined by forces external to the region.
3. Non-basic activities depend on and support basic activities, and their future is determined by internal forces which can be represented by a multiplier linking the basic sector to total regional activity.
4. This multiplier is determined by historical relationships observed within a region for particular sectors, industries, or activities.
5. When you know what the value of the multiplier ratio is, it is possible to derive an estimate of total regional impact of a given change in the basic sector of the region's economy.
In short, if you can calibrate the magnitude of the ripple effect, you can predict impacts to the whole economy from changes in the basic sector.
The full model, which includes the previous discussion of the B:NB ratio is:
TA = B + NB
and,
NB = f(B)
where,
TA: Total economic activity (growth/decline).
B: Basic activity.
NB: Non-Basic activity.
In its most elementary form, EBT postulates a simple constant relationship between basic and non-basic activity.

71. Calculating Economic Base
This model can be developed even further to incorporate all the iterations that must be accounted for when a new basic job is created:
TE = DE + IE + ME + FE + HD
where,
TE: total induced employment.
DE: Direct induced employment (basic export jobs, all B).
IE: Indirect induced employment (spin-off industries NB + some B).
ME: Indirect municipal employment (services & NB jobs, mostly NB).
FE: Indirect final demand (created by iteration, all NB).*
HD: Indirect household demand (created by families of all workers, all NB).
*Iteration is the process by which non-basic jobs create other non-basic jobs, etc.
2.5
Finally, the model is further complicated by the population multiplier, in which the family members of any new workers coming to the region to fill any of the jobs, will also require support and hence generate non-basic jobs themselves.
Even if the new basic jobs go to people already in the region, the level of both personal and public (taxes) income can be assumed to increase over that which existed before, thus generating increased demand for products and services, and hence even more non-basic jobs.
In short, the multiplier is an extremely important concept and a measure of total impact. However, due to its complexity it is very difficult to put into practice and hence is very difficult to accurately estimate.

72. Calculating Economic Base
May all seem pretty easy and it is – it’s just arithmetic after all. But the devil is in the details.
To calculate an economic base, even assuming the f in NB+(f)B exists and the relationships are all constant over time as space, you would need:
Accurate and timely employment data for economic activities.
Some type of categorization for those activities, at a small enough sectoral scale to be useful (resource, manufacturing, service sectors is not).
Are the data available at a small enough spatial scale for your community?
Do we have all this? And if so where would one find all this?

73. Issues With EBT 
It assumes that a relationship exists between B and NB jobs, which is probably O.K., but is this relationship constant: Over time? Do we get more efficient at providing non-basic jobs; i.e. the relationship between the basic and non-basic sectors is probably some curvilinear and not linear relationship. Over city size? Are larger cities more efficient at providing support for new basic jobs, given scale economies? Over magnitude of B? That is, does every one of the new B jobs generate in the same ratio as the first? Backwards?? That is, does the negative multiplier work in the same ratio as the positive multiplier? What proportion of the NB jobs are actually B? People who use the malls in a place do not all come from that place. The two problems mentioned earlier with respect to boundaries and exactly what activities are B and NB.
6. Problems With EBT.
While economic base theory is an important conceptual tool for examining the economic structure of areas, and particularly the contribution of its manufacturing activities, it is nonetheless only a quick and dirty method of estimating impacts for the following reasons:
1. It assumes that a relationship exists between B and NB jobs, which is probably O.K., but is this relationship constant:
i. Over time? Do we get more efficient at providing non-basic jobs; i.e. are there scale economies to, say, providing groceries? If so the ratio should taper off with time and wind the iteration down. I.E. the relationship between the basic and non-basic sectors is curvilinear and not linear.
ii. Over city size? Are larger cities more efficient at providing support for new basic jobs, given the scale economies argument above? I.E. the relationship between the basic and non-basic sectors is curvilinear and not linear.
iii. Over magnitude of B? That is, does every one of the new B jobs generate in the same ratio as the first? I.E. the relationship between the basic and non-basic sectors is curvilinear and not linear.
iv. Backwards?? That is, does the negative multiplier work in the same ratio as the positive multiplier? Put another way, can we use the same multiplier to see how many NB jobs would be lost should a region lose B jobs?
2. What proportion of the NB jobs are actually B? People who use malls in a place do not all come from that place. There is always a region serving function for the so-called non-basic sector.
3. The two problems mentioned earlier with respect to boundaries and defining exactly what activities are B and NB should also be listed here.

74. Summary Of EBT
 Despite the issues, EBT has much utility in conceptualizing, describing and explaining why spatial economies work the way that they do and we will be returning to it on many occasions throughout this course.
6. Problems With EBT.
While economic base theory is an important conceptual tool for examining the economic structure of areas, and particularly the contribution of its manufacturing activities, it is nonetheless only a quick and dirty method of estimating impacts for the following reasons:
1. It assumes that a relationship exists between B and NB jobs, which is probably O.K., but is this relationship constant:
i. Over time? Do we get more efficient at providing non-basic jobs; i.e. are there scale economies to, say, providing groceries? If so the ratio should taper off with time and wind the iteration down. I.E. the relationship between the basic and non-basic sectors is curvilinear and not linear.
ii. Over city size? Are larger cities more efficient at providing support for new basic jobs, given the scale economies argument above? I.E. the relationship between the basic and non-basic sectors is curvilinear and not linear.
iii. Over magnitude of B? That is, does every one of the new B jobs generate in the same ratio as the first? I.E. the relationship between the basic and non-basic sectors is curvilinear and not linear.
iv. Backwards?? That is, does the negative multiplier work in the same ratio as the positive multiplier? Put another way, can we use the same multiplier to see how many NB jobs would be lost should a region lose B jobs?
2. What proportion of the NB jobs are actually B? People who use malls in a place do not all come from that place. There is always a region serving function for the so-called non-basic sector.
3. The two problems mentioned earlier with respect to boundaries and defining exactly what activities are B and NB should also be listed here.

75. ECONOMIES OF SCALE 12. ECONOMIES OF SCALE AND INDUSTRIAL LINKAGES
1. Introduction.
This section will deal with the way in which industries restructure their production process to achieve internal economies of scale, and how they aggregate together to achieve external economies of scale.
It will also deal with the idea of linkages, or how firms are connected together with their suppliers, their customers, and their competitors.
2. Internal Economies of Scale.
1. Introduction:
Internal economies of scale refers to the way a firm reorganises itself internally such that cost savings and/or revenue gains per unit of production can be achieved.
There are two central ways in which internal economies of scale are achieved:
1. Productivity increases due to:
- labour reductions proportional to machines (capital);
- bulk buying of raw materials;
- specialisation of production process.
2. Revenue enhancement due to:
- control of market share through volume production;
- price control, especially if the activity is an oligopoly;
2. Economics of Internal Scale Economies:
1. Variable Cost of Output:
Production costs per unit of output are not uniform; that is, as quantity of output increases, the cost of each unit of output decreases, to a point, then increases again:
Variable Cost Model
COST
PER
UNIT
0_________________________________________
quantity of output ---->
In the model, cost per unit decreases with quantity produced, then increases once again due to diminishing returns.
This relationship can be explained by outlining production functions, marginality, and diminishing returns.
2. Production Functions:
A production function is the relationship between quantity of inputs and quantity of output:
Y = f (x1, x2, ... , xn)
where,
Y = quantity of output.
x = quantity of `n' different inputs (e.g. factors of production).
When analyzing production functions, usually one variable is allowed to change value while all others are kept constant:
Y = f (x1 | x2, ... ,xn)
varies fixed
3. Diminishing Returns:
The production function relationship is affected by the Law of Diminishing Returns to Scale (LODR), which is:
"As the quantity of a variable input is increased, the output, or total product, will....
- first increase at an increasing rate,
- then at a constant rate,
- then at a diminishing rate,
- will reach a maximum,
- then decline."
The rationale behind the LODR can be seen in a simple example:
1. If an item has three stages of production and one person takes one hour to produce one item, then the output is one item/per person/per hour.
2. If three persons (labour, the variable input) each take a stage, then output can be doubled to two units per hour. This occurs because:
- of increased dexterity: you get better as time goes by if you do the same small job;
- you save time from not having to move from task to task;
- encourages the use of specialised tools and machinery that are only economical if they are used for the maximum period of time.
3. However, when six, eight, or twelve persons try to use the same workbench, machines, factory floor (fixed inputs), they soon get in each other's way.
4. Thus, when one factor of production (labour) is allowed to vary while other factors (machines, space) are kept constant, then scale diseconomies soon become a reality.
After all, no amount of miracle fertiliser is going to let you grow enough food to feed the world in a flowerbox, as long as the size of the flowerbox is kept constant.
Using hypothetical data and an agricultural example will illustrate the LODR, and also serve to illustrate some other important terms such as total output, average output, and marginal output.
[OH:TABLE 19.I,FIG 19.3, MCCONNEL/POPE]
In the example, if we fix inputs x2, ... xn (say, land, labour, etc.), and allow only manpower to increase (x1), then:
- total output peaks at 7 million person years, but ...
- average output peaks at 2 million person years while marginal output peaks between 1 million and 2 million person years.
Note that point of highest marginal is often difficult to estimate, so average cost per unit is used to approximate it.
The optimum output is not as much as you can get, but as much as much as you can get for as little as you have to give.
That is, the optimum output will be between 1 and 2 million person years of input (the marginal output level) because for every person year above this level, you get less return per person year (see definition of marginal product).
A Production Function for
Y = f (x1| x2, ..., xn)
UNITS Total
Product OF
Region Region 2 Region 3
OUTPUT 1 (feasible
zone of
`Y' production)
Average Product
Marginal
_______________________________________________
0 Units of Input x1
Their are four cost to output functions, or internal scale economies curves:
COST Marginal
Cost
Average Total Cost
(Sum of AVC and AFC)
Average Variable Cost (AVC)
Average Fixed Cost(AFC)
0_______________________________________________
Output (Y)
1. Fixed costs of production decline as quantity produced increases and costs are spread.
2. Variable costs of production increase with quantity produced.
3. Average total costs = fixed + variable costs divided by the number of units output.
4. Marginal cost = change in total cost divided by change in output, or the change in total costs associated with each new unit of output. I.E. how much extra output do you get for every extra unit of input?
3. Restrictions on Internal Economies:
There are four restrictions that apply to internal scale economies:
1. Indivisibility Thresholds:
There is a simple economic principle that holds when using machines: to get the best return on investment you must use a machine continually to produce output.
Thus the indivisibility threshold says that since machines come in single indivisible whole units with a given capacity of output, you must have the potential to sell all or nearly all of the new output before you can use the machine.
For example, if a shirt manufacturing machine outputs 30 shirts a week, the manufacturer must be able to sell that many shirts to justify the purchase of the machine.
If she makes 7 shirts a week by hand presently, then her indivisibility threshold is 23 extra shirts sold per week before she can justify a machine.
But if she mechanises, her costs per shirt go down and so will her prices, thus leading to more shirt sales; the question is, can she sell the extra 23 shirts.
2. Machines Require Inputs:
Large scale machine operations require large scale expansions in other factors of production and distribution, upstream and downstream.
That is, the LODR suggests that while you may be able to produce bigger and better machines, you will always run into the problem of limiting factors; that at some point either upstream or downstream from the machine, some factor will cause a bottleneck in production output.
By way of example, the advent of wide body jets required associated expansions in baggage and passenger handling facilities; more labour, space, customs, check-ins, security, transit, parking, access to airports, etc., all the way down the line.
3. Mass Consumption Required:
Large scale production requires large scale consumption of the outputs, and thus leads to a consumer society focused on disposable products, built in obsolescence and demand creation marketing strategies.
These in turn create an economic market system where consumption fuels growth and production feeds consumption, all of which encourages irresponsible resource use and environmental degradation.
4. Downtime:
Machine downtime means that for the five minutes of any hour that the machine is not running, it has an infinitely steep cost per unit output curve.
So large scale machine operations require substantial support structures (mechanics, spares) in order to minimise downtime, or many machines in order to spread the downtime costs over total output.
Likewise, cost per unit output goes up when machines are not working at full capacity due to lack of demand for output (see Capacity Utilisation Rates in Performance Statistics section in this volume).
4. Evidence of Internal Economies of Scale?:
[OH:WRITTEN, LLOYD/DICKEN, P275]
There is great variation in production optima both between different plants and within single plants.
Also, to a large degree production optima are based on technology, which changes rapidly, and thus a plant can be very efficient with respect to its own machinery and system, but only fair when compared to the most modern systems operating.
Evidence is very strong for increasing returns to scale up until the 1920s in North America (mainly the USA), and that generally meant in single plant operations.
Fragmentation of production to the multi-plant format was a post depression innovation, when it was discovered that there was such a thing as diseconomies of scale in the operation of the single plant production facility.
That is, it was possible to get too big; there was an optimum size to a production facility that was not necessarily the maximum size the facility could be.
The best example of this is found in Ford's Rouge River Plant in the 1920s, where production lines got too long and breakdowns in the conveyor system created havoc - a ten minute stoppage at one end to fix a roller would mean four hours before the system could be up to speed at the other end (much like the wave effect in transportation flows - slow down by five mph to look at an accident and two miles back its stop and go).
Ironically, part of the assembly line system Ford innovated included turning people into machines which gave impetus to the labour union movement in that industry.
Managers had no idea what was going on across the huge layout, and parts couldn't be supplied fast enough to feed the production line, which created bottlenecks that reduced the speed of the line to a half of its potential.
The result was the realisation that single plant returns to scale had a limit, and that more and smaller plants functioning at marginal returns to scale worked better.
However, the optimum size for plants varies depending on the product they make; chemical plants, especially those cracking hydrocarbons, appear to have no upper limit in output to cost, so the larger they are, the cheaper per unit cost of production.
They are the exception, however, and most plants do have optimum output sizes.
Historically, the consequence of achieving internal scale economies for location was obvious: the market could be served by a reduced number of larger plants, but those plants had to be re-organised (see Industrial History section in this volume).
The reason for this smaller number of larger plants revolved around the operation of price competition, similar to Palander's ideas on market areas and revenue generation:
COSTS
__________________________________________
A y x B x y C
`x' are the market edges at equal competitive price, which is a function of equal production costs at all three plants, A, B, & C. Any attempt by B to lower its costs to gain market share to `y' can and will be matched by A and C and thus market boundaries will be re-established.
___________________________________________
x A B C x
`x' are the market edges when B lowers its costs by achieving internal economies of scale, which in turn allows it to lower its prices and establish new market boundaries that cannot be re-established by A and C because they have not achieved internal economies of scale.
The locational consequence is that A and C are either bought out or bankrupted, and the system shifts towards an oligopolistic or monopolistic market system.
3. External Economies of Scale:
This type of scale economy is also known as an agglomeration economy; Weber called them "social agglomeration economies".
An external economy of scale refers to the advantages that an industry gains from grouping together with other industries and activities at a given place or point.
Daggett (1955) defines the term succinctly:
"An agglomeration point is merely a place to which a number of persons engaged in an industry decide to resort. Without the decision it does not exist; after the decision it is there. Looked at from another point of view, a point for agglomeration is not one to which it is to the advantage of any single producer to transfer his plant. While it may be to the advantage of two producers to come together, neither will gain unless the other also acts."
Study of agglomeration economies emphasises the linkages between economic activities within a relatively restricted geographic area.
They serve as the raison d'etre for regional development policy, which attempts to establish a regional complex of connected activities centred on one or more manufacturing activities that are brought into an area through incentives.
But any single firm is only one part of a complex web of connections that allow it to produce its product, and it is through optimising these linkages that a firm realises external economies of scale.
There are three types of linkages:
1. Production Linkages:
These involve backward linkages to suppliers and forward linkages to customers.
These linkages also involve the sub-contractor who specialises in one small part of the production process, such that a firm may be said to have part of its division of labour outside itself.
2. Service Links:
These are linkages that are ancillary to the production process.
They support the process and involve such things as accounting, technical and mechanical repairs, window cleaners, payroll etc.
3. Marketing links:
These links are responsible for packaging, distributing and selling the product, and involve such activities as transportation functions, marketing companies, cardboard box makers, etc.
As a general rule larger plants internalise more of these linkages, and producers of highly complex products tend to have more complex sets of linkages.
However, there is less internalisation in the modern plant than there used to be due to the process of rationalisation where:
1. firms hive off services that can be contracted, such as personnel hiring and accounting;
2. firms specialise the production process by subcontracting elements of production (such as spray-painting components), and using more semi-finished components.
In short, agglomeration economies exist in a relatively small geographic area where savings in cost and increases in revenue can be realised by proximity to other economic activities.
One common distinction that is made in discussing external economies of scale is that of (1) localisation economies, and (2) urbanisation economies.
1. Localisation Economies:
Localisation economies are single sectors or sets of manufacturing activities that are related to one another, such as the clothing industries.
Industries that are similar benefit from grouping together through such things as the mass purchase of materials, mass markets, availability of specialised services no-one single member could afford, common skilled labour pool, being part of the `clothing area'.
Good examples of localisation economy are New York City's garment district, Silicon Valley, and Birmingham's jewelry section:
[OH:FIG 7.18, LLOYD/DICKEN]
From a locational perspective, localisation economies can build up significant `inertia', where they become fixed areas of production of that product group to the point where banks are reluctant to invest, for example, in any company wishing to make clothes but not locate in the `garment district'.
2. Urbanisation Economies:
These refer to the overall benefits accruing to all the diverse companies that locate in an area and share a common pool of services that none of the firms individually could afford:
URBANISATION ECONOMY
_____________________________________________________________
- Clothing Trade |
- Steel - Trucking - Button-makers -
- Autos - Security - Textile Manufacture -
- Electrical - Labour - Thread Makers -
- Food - Janitorial - Dry Cleaners -
- Shoes - Packaging - Cutters & Tailors -
_____________________
LOCALISATION ECONOMY
The connection to economic base theory should be evident when discussing agglomeration economies; what are the basic and non-basic activities in the above diagram?
Just as there is a point when internal scale economies become diseconomies, so there is a point when crowding, congestion, and expensive land contributes to the diseconomy of the urban area, usually leading to decentralisation (among other reasons) of manufacturing from the inner cities at least. These factors are termed negative externalities.
One final aspect of agglomeration economies worth noting is that at a macro scale, the Southern Ontario heartland can be seen to be the agglomeration economy of Canada, and it is very difficult for the other regions of the country to provide adequate `inertia' of their own to overcome the locational importance that the heartland has, simply by virtue of having such a weight of manufacturing and services already.

76. Internal Economies Of Scale External Economies Of Scale
Internal Economies Of Scale
External Economies Of Scale
Definition:
The reduction in unit costs of production realized when more units are produced.
I.E.
The more units you make the cheaper each unit is to make.
BUT ONLY TO A POINT.
Definition:
The reduction in costs of production realized from clustering together with other economic activities.
I.E.
The more economic activities gather together, the cheaper it becomes to produce things.
BUT ONLY TO A POINT.

77. Internal Economies Of Scale External Economies Of Scale
Internal Economies Of Scale
External Economies Of Scale
Economics of ISE:
Cost per unit reductions.
Productivity increases.
Revenue enhancements.
Limitations of ISE:
Indivisibility thresholds.
Matching inputs to scales.
Mass consumption required.
Downtime.
Localization effects:
Effects of like industry clustering.
Reduced cost of inputs.
Urbanization effects:
Effects of shared resource pool.
Effects of shared infrastructure.
Linkages.
More demand.

78. Internal Economies Of Scale
Internal Economies Of Scale
Goal: Increase profits by reducing unit costs of production
Economics of ISE:
Cost per unit reductions.
Production function, diminishing returns, marginality.
Productivity increases.
Capitalization, bulk buying, specialization of production process.
Revenue enhancements.
Control of market share/price through volume.
Limitations of ISE:
Indivisibility thresholds.
Matching inputs to scales.
Mass consumption required.
Downtime.

79. The Production Function
A production function is the relationship between quantity of inputs and quantity of outputs, & is given by:
Y = f(x1, x2, .., xn)
Where:
Y is the output
x is the quantity of various inputs
And the function is defined as:
Y = f(x1 | x2, .., xn)
varies | fixed
That is, only one variable is allowed vary in quantity while the others are fixed.
The production function gives rise to the law of diminishing returns.
Factors of production
WARNING!!
Economics

80. The Law of Diminishing Returns
If every unit of input produced the same unit of output the production function would be a 45 degree line. But…
OUTPUT
INPUT

81. The Law of Diminishing Returns
A production function is affected by the law of diminishing returns to scale, which states that as the quantity of one variable of input is increased while the others are held constant, the output or total product will…
reach a maximum (=00)…
then at a diminishing rate (<450)…
OUTPUT
then at a constant rate (= 450)…
then decline.
first increase at an increasing rate (>450)…
INPUT

82. Marginality 
Important concept in economics because it demonstrates that “best” and “most” are not the same.
The approach here is the same as that of comparative advantage: it is not about absolutes but about relatives.
Marginality is a measure of the output you get from the last unit of input.
In other words, why invest more input than you need to in order to produce output.
Most of us think of reward as getting the most we can but marginality thinks of reward as getting the most for the least.

83. So there are three types of “maximum” output here.
MEASURE OF INPUT
MEASURES OF OUTPUT
Inputs of labour in millions of person hours
Total production millions of units
Marginal product in millions of units (difference between each new unit of output for each new unit of input)
Average production millions of units per million person hours (total production/input)
100 1
150 2
250
125 3
375
101 4
476
119 74 5
550
110 50 6
600 30 7
630 90 -6 8
624 78
So there are three types of “maximum” output here.
100-0=
DIMINISHING RETURNS = =
Highest marginal production
Highest average production.
Maximum amount of production.

84. Internal Economies of Scale – Margins of Production
THE GOLDILOCKS ZONE
TOO FEW
PRODUCED
TOO MANY
PRODUCED
Quantity at which maximum output is reached and marginal returns to inputs reaches zero.
Quantity at which marginal returns to inputs begin to decline
Point of internal scale economies is not to produce as much as you can get.
It is to produce as much as you can get for as little as you have to give.
Quantity at which average returns to inputs begin to decline
Point of internal scale economies is not to produce as much as you can get but to produce as much as you can get for as little as you have to give.

85. Cost Curves Generalised

86. The Cost Curve
A cost curve is produced by the way fixed and variable costs combine
Total cost curve is the sum of the fixed and total costs.
COST
Fixed cost is constant with quantity produced. E.G. rent of factory.
Variable cost increases with quantity produced. E.G. raw materials.
QUANTITY PRODUCED

87. Cost Curve Data
But when we consider unit costs, the lines become curvilinear. A B C
D=B+C
B/A
C/A
D/A
Units of Output (millions)
Fixed Costs of Production
Variable Costs of Production
Total Costs of Production
Fixed Unit Cost of Production
Variable Unit Cost of Production
Total Unit Cost of Production 1 10 11
10.00
1.00
11.00 2 12
5.00
6.00 3 13
3.33
4.33 4 14
2.50
3.50 5 15
2.00
3.00 6 16
1.67
2.67 7 17
1.43
2.43 8 18
1.25
2.25 9 19
1.11
2.11 20

88. Production Cost Curves Plotted

89. UNIT COST CURVES PLOTTED
NOTE:WHEN COSTS ARE AVERAGED OVER NUMBER OF UNITS, UNIT COSTS DECREASE AT A DECREASING RATE OVER NUMBER OF UNITS PRODUCED.
Effect of diminishing returns seen here in the different unit cost curve slopes.

90. Internal Economies of Scale Unit Cost Curve
Diseconomies of scale
Average Unit Cost
Costs per unit decrease but at different rates
Effect of diminishing returns seen here. C1 Q1
Quantity of Output

91. Internal Economies of Scale Profit Generated Per Unit
The ability to produce many units at lower costs per unit gives a manufacturer the opportunity to reduce prices, increase demand, and so maintain the profit margin per unit. But profits increase and decrease to scale as well.
Economies of scale
Diseconomies of scale
Average Unit Cost
Revenue per Unit
Increasing profit to scale
Decreasing profit to scale
Profit Per Unit
Maximum Profit Per Unit
Quantity of Output

92. Example: assembly costs of various small cars in E.U.
At 15,000 units produced, assembly cost per unit
At 45,000 units produced, assembly cost per unit
At 195,000 units produced, assembly cost per unit

93. Example – Parts fabrication cost of various small cars, EU
At 12,000 units produced, fabrication cost per unit for Audi and Lupo Hybrid for Lupo Steel.
At 195,000 units produced, fabrication cost per unit for Lupo Hybrid & Audi, for Lupo. Steel

94. Parts cost breakdown for small cars, EU
60,000 cars annually
95,000 cars annually
Largest returns to scale found in tooling costs

95. Restrictions on Internal Economies
Indivisibility threshold:
To be cost effective, machines must produce at their maximum output.
Large scale operations require large scale inputs:
Upstream, instream, and output bottlenecks always appear as scale increases.
Mass consumption required:
Large scale mass output requires mass consumption that can absorb the output.
Downtime:
The unit cost curve for machine downtime is vertical (infinite cost for zero output), the reason why retooling is expensive.
There are four restrictions that apply to internal scale economies:
1. Indivisibility Thresholds:
There is a simple economic principle that holds when using machines: to get the best return on investment you must use a machine continually to produce output. Thus the indivisibility threshold says that since machines come in single indivisible whole units with a given capacity of output, you must have the potential to sell all or nearly all of the new output before you can use the machine. For example, if a shirt manufacturing machine outputs 30 shirts a week, the manufacturer must be able to sell that many shirts to justify the purchase of the machine. If she makes 7 shirts a week by hand presently, then her indivisibility threshold is 23 extra shirts sold per week before she can justify a machine. But if she mechanises, her costs per shirt go down and so will her prices, thus leading to more shirt sales; the question is, can she sell the extra 23 shirts.
2. Machines Require Inputs:
Large scale machine operations require large scale expansions in other factors of production and distribution, upstream and downstream. That is, the LODR suggests that while you may be able to produce bigger and better machines, you will always run into the problem of limiting factors; that at some point either upstream or downstream from the machine, some factor will cause a bottleneck in production output. By way of example, the advent of wide body jets required associated expansions in baggage and passenger handling facilities; more labour, space, customs, check-ins, security, transit, parking, access to airports, etc., all the way down the line.
3. Mass Consumption Required:
Large scale production requires large scale consumption of the outputs, and thus leads to a consumer society focused on disposable products, built in obsolescence and demand creation marketing strategies. These in turn create an economic market system where consumption fuels growth and production feeds consumption, all of which encourages irresponsible resource use and environmental degradation.
4. Downtime:
Machine downtime means that for the five minutes of any hour that the machine is not running, it has an infinitely steep cost per unit output curve. So large scale machine operations require substantial support structures (mechanics, spares) in order to minimise downtime, or many machines in order to spread the downtime costs over total output. Likewise, cost per unit output goes up when machines are not working at full capacity due to lack of demand for output (see Capacity Utilisation Rates in Performance Statistics section in this volume).
4. Evidence of Internal Economies of Scale?:
There is great variation in production optima both between different plants and within single plants.
Also, to a large degree production optima are based on technology, which changes rapidly, and thus a plant can be very efficient with respect to its own machinery and system, but only fair when compared to the most modern systems operating.
Evidence is very strong for increasing returns to scale up until the 1920s in North America (mainly the USA), and that generally meant in single plant operations.
Fragmentation of production to the multi-plant format was a post depression innovation, when it was discovered that there was such a thing as diseconomies of scale in the operation of the single plant production facility.
That is, it was possible to get too big; there was an optimum size to a production facility that was not necessarily the maximum size the facility could be.
The best example of this is found in Ford's Rouge River Plant in the 1920s, where production lines got too long and breakdowns in the conveyor system created havoc - a ten minute stoppage at one end to fix a roller would mean four hours before the system could be up to speed at the other end (much like the wave effect in transportation flows - slow down by five mph to look at an accident and two miles back its stop and go).
Ironically, part of the assembly line system Ford innovated included turning people into machines which gave impetus to the labour union movement in that industry.
Managers had no idea what was going on across the huge layout, and parts couldn't be supplied fast enough to feed the production line, which created bottlenecks that reduced the speed of the line to a half of its potential.
The result was the realisation that single plant returns to scale had a limit, and that more and smaller plants functioning at marginal returns to scale worked better.
However, the optimum size for plants varies depending on the product they make; chemical plants, especially those cracking hydrocarbons, appear to have no upper limit in output to cost, so the larger they are, the cheaper per unit cost of production.
They are the exception, however, and most plants do have optimum output sizes.
Historically, the consequence of achieving internal scale economies for location was obvious: the market could be served by a reduced number of larger plants, but those plants had to be re-organised (see Industrial History section in this volume).
The reason for this smaller number of larger plants revolved around the operation of price competition, similar to Palander's ideas on market areas and revenue generation:
COSTS
__________________________________________
A y x B x y C
`x' are the market edges at equal competitive price, which is a function of equal production costs at all three plants, A, B, & C. Any attempt by B to lower its costs to gain market share to `y' can and will be matched by A and C and thus market boundaries will be re-established.
___________________________________________
x A B C x
`x' are the market edges when B lowers its costs by achieving internal economies of scale, which in turn allows it to lower its prices and establish new market boundaries that cannot be re-established by A and C because they have not achieved internal economies of scale.
The locational consequence is that A and C are either bought out or bankrupted, and the system shifts towards an oligopolistic or monopolistic market system.

96. Ford Motor Company, Rouge River Plant
Largest integrated factory in the world in 1928.
93 buildings, 16 million square feet, 100,000 employees.
Had its own dock, electrical plant, and steel smelting plant, a glass making plant, and over 160 kilometers of internal railroad.
Ran into issues daily with supplying the plant, getting output off the site, and with mechanical problems.
A classic example of scale diseconomies.

97. External Economies Of Scale
Definition:
The reduction in costs of production realized from gathering together with other economic activities.
I.E.
The more economic activities gather together, the cheaper it becomes to produce things.
Localization effects:
Effects of similar industries clustering.
Urbanization effects:
Effects of shared resource pool.
Effects of shared infrastructure.
Linkages.
More demand.

98. URBANISATION ECONOMIES
STORES
POLICE
HOSPITALS
URBANISATION ECONOMIES
LOCALISATION
ECONOMIES
Logistics
Forestry
Paper air filters
Wood
veneer
Packaging
Upholstery
Automakers
HR consultants
Light bulbs
Metal fabricating
Finance
Electronics
Janitorial supply
Batteries
Glass products
Transportation
Rubber products
GOVERNANCE
Labour pool
Wiper blades
SCHOOLS
PEOPLE

99. Here endeth the lesson.