Assignment 1 for Physical Distribution Management
Questions for the paper “Retail location theory: The legacy of Harold Hotelling”:
H1) Can you describe the PMD including its relationship with Hotelling’s model?
Hotelling’s model (1929) is built around two profit-maximizing firms selling an identical product in a bounded linear market with constant transportation rates. The locations of the firms are fixed, demand is inelastic and identical. The utility maximizing consumers are evenly distributed, bear the transportation costs, and patronize low prices. Hotelling demonstrated that there is an equilibrium where neither of the firms would increase its profits by decreasing prices. The model is a private case of the principle of minimum differentiation. Hotelling maintained that the principle holds true for both plain and linear markets, it could be established when consumers are unevenly distributed, it remains valid when more than two retailers are participating, and explains the standartization of most aspects of life.
H2) Discuss weaknesses of Hotelling’s model.
Hotelling’s model includes only two firms. Chamberlin (1933) demonstrates that the introduction of a third firm would result in the loss of the middle one’s hinterland. Therefore, an equilibrium would be reached when the firms are located at the quartiles of the bounded linear market. Moreover, the topic has been studied with up to 256 participating firms and the conclusion is that a dispersed pairing of firms is observed, dubbed “the principle of local clustering” by Eaton and Lipsey (1975). Furthermore, it has been demonstrated by various scholars that, if the market is two-dimentional, the market participants will be optimally located equidistant from each other in the socially optimal area of the market. Moreover, even Hotelling himself recognized that if his model allowed for elastic demand and/or transportation costs were covered by suppliers, they would disperse. Although the model assumed zero conjectural variation, in reality there are a variety of behaviors that firms can have in reaction to changes in the market landscape.
H3) Principle of Maximal differentiation: When? How?
The principle of maximal differentiation states that firms recognize that their proximity would have a negative effect on their profitability because of the increased price competition between them (Richardson 2004). Therefore they try to distance themselves from each other as much as possible. As with the principle of minimum differentiation, here it is assumed that the sellers provide identical products and the demand for their product is equally distributed across the market.
H4) Is there an alternative “proof” for the PMD?
Agglomeration of competitors leads to cost reductions and shared benefits for thm. It also provides a significant uncertainty reduction for the sellers. Since they are not perfectly informed and it is reasonable to assume that they aim to reduce their risk, Webber (1972) has demonstrated that the inevitable outcome of their behavior would be the agglomeration of shops. Moreover, if there is a particular shop that clearly generates good profit, there will be other suppliers who will open business next to it in an attempt to capture some of its market share, thus also leading to agglomeration. Also, since consumers are prone to seek information when making purchasing decisions, suppliers provide a social benefit when they cluster together. Wolinsky (1982) shows that negative effects of the proximity of competing businesses are more than offset by the increased demand that occurs with agglomeration.
Questions for the paper “Clusters and the new economics of competition”
C1) Give at least five examples of clusters in the Netherlands or other European countries other than those mentioned in Porter’s contribution. The French Riviera;
the financial district in...
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