Market Potential, Increasing Returns, and Geographic Concentration

Gordon H. Hanson

NBER Working Paper No. 6429
Issued in February 1998
NBER Program(s):International Trade and Investment

In this paper, I examine the relationship between increasing returns to scale and the geographic concentration of economic activity. Using data on U.S. counties, I estimate the structural parameters of the Krugman (1991) model of economic geography. The specification I use, which is derived from the equilibrium conditions of the model, resembles a spatial labor demand function as it is proximity to consumer markets tha determines nominal wages and employment in a given location. Parameter estimates show support for small but significant scale economies; the estimated price-marginal cost ratio is 1.1 in 1980 and 1.2 in 1990. The parameter estimatines also suggest that geographic concentration is a stable feature of the spatial distribution of economic activity. As a prelude to the analysis, I estimate a reduced form of the Krugman model which approximates Harris' (1954) market-potential function. The estimation results show how far demand linkages extend across space and how shocks to income in one location affect wages and employment in other locations. Demand linkages between regions are strong and growing over time, but limited in geographic scope. Simulations based on parameter estimates suggest that a 10% fall in personal income for a region the size of Illinois reduces employment by 6.0-6.4% in counties that are 100 km in distance, with effects declining to zero for counties more than 800 km in distance. The results are consistent with a high volume of trade within cities and between proximate cities.

download in pdf format
   (3506 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w6429

Published: Hanson, Gordon H. "Market Potential, Increasing Returns And Geographic Concentration," Journal of International Economics, 2005, v67(1,Sep), 1-24. citation courtesy of

Users who downloaded this paper also downloaded* these:
Krugman w3275 Increasing Returns and Economic Geography
Krugman w4219 A Dynamic Spatial Model
Hanson w8013 Scale Economies and the Geographic Concentration of Industry
Hanson w6587 North American Economic Integration and Industry Location
Ellison and Glaeser w4840 Geographic Concentration in U.S. Manufacturing Industries: A Dartboard Approach
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us