Location theory has become an integral part of economic geography, regional science, and spatial economics. Location theory addresses questions of what economic activities are located where and why. Location theory or microeconomic theory generally assumes that agents act in their own self-interest. Firms thus choose locations that maximize their profits and individuals choose locations that maximize their utility. Location theory deals with questions concerning what economic activities are located where and why and looks at the spatial organization of production, exchange and consumption. In its microeconomic formulation, location theory supposes that agents act in their own self-interest: the firm chooses locations which maximize profits, while the individual chooses locations which maximize utility. The theory examines the influences of transport costs, land rents, economies of scale, market access, agglomeration economies and market structure on these locational decisions. By modelling the trade-offs between distance, costs and benefits, location theory is useful for explaining patterns of spatial concentration and dispersion, such as the emergence of cities, industrial clusters and regional specialisation. Modern spatial economic models focus on interaction between increasing returns and trade costs in the formation of core-periphery structures and regional differences. The foundations of location theory were established in the nineteenth and early twentieth century using classical models such as the agricultural land use theory of Johann Heinrich von Thunen, the industrial location theory of Alfred Weber, and the central place theory of Walter Christaller. These early contributions set up the frameworks for analysing the structure of distance and market areas and economic activity. The field was revived in the "new economic geography" in the late twentieth century, most notably the work of Paul Krugman, who incorporated increasing returns and imperfect competition into formal models of spatial concentration. Today, location theory is still at the heart of the analysis of urban systems, industrial clustering, regional inequality, global supply chains and economic development. It gives a theoretical foundation for economic geography by explaining decision-making processes that create spatial patterns of production and trade that can be observed in space.
History
Transportation costs
While others should get some credit for earlier work (e.g., Richard Cantillon, Etienne Bonnot de Condillac, David Hume, Sir James D. Steuart, and David Ricardo), it was not until the publication of Johann Heinrich von Thünen's first volume of Der Isolierte Staat in 1826 that location theory can be said to have really gotten underway. Indeed, the prominent regional scientist Walter Isard has called von Thünen "the father of location theorists." In Der Isolierte Staat, von Thünen notes that the costs of transporting goods consumes some of Ricardo's economic rent. He notes that because these transportation costs and, of course, economic rents, vary across goods, different land uses and use intensities will result with increased distance from the marketplace. However, the discussion was criticized since Johann Heinrich von Thünen oversimplified the problem with his assumptions of, for example, isolated states or single cities. A German hegemony of sorts seems to have taken hold in location theory from the time of von Thünen through to Walter Christaller's 1933 book Die Zentralen Orte in Sűddeutschland, which formulated much of what is now understood as central place theory. An especially notable contribution was made by Alfred Weber, who published Über den Standort der Industrien in 1909. Working from a model akin to a physical frame adapted from some ideas by Pierre Varignon (a Varignon frame), Weber applies freight rates of resources and finished goods, along with the finished good's production function, to develop an algorithm that identifies the optimal location for manufacturing plant. He also introduces distortions induced by labor and both agglomerative and deglomerative forces. Weber then discusses groupings of production units, anticipating August Lösch's market areas. Carl Wilhelm Friedrich Launhardt conceived much of that for which Alfred Weber received credit, prior to Weber's work. Moreover, his contributions are surprisingly more modern in their analytical content than are Weber's. This suggests that Launhardt was ahead of his time and not readily understood by many of his contemporaries, for instance he showed that railways cannot be fully developed by private capital alone.
Whether Weber was familiar with Launhardt's publications remains unclear. Weber was most certainly influenced by others, most notably Wilhelm Roscher and Albert Schäffle, who seem likely to have read Launhardt's work. Regardless, location theoretical thought blossomed only after Weber's book was published. The Swedish economist Tord Palander completed a 1935 PhD, Contributions to Location Theory, which considered the market area division of two competing firms. The American economist William Henry Dean, Jr. completed his Harvard PhD in 1938, The theory of the geographic location of economic activities.
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