Modeling tricks and approaches have removed key technical barriers to the study of geography and distance in economics. Revived research interest in where economic activity occurs and why as well as in the physical distribution of wealth and peoples has led to the rise of spatial economics. Spatial economics exists at the intersection of econometrics, geographic information science, and data analytics to identify and answer real-world concerns like the extent to which constructing inter-regional transportation infrastructures can help reduce inequality or integrating networks of suppliers, distributors, consumers, and community across spaces can increase the competitiveness of local food producers. In the aggregate, these microeconomic relationships are foundational to maximizing the efficiency of trade bloc agreements or minimizing disease and disaster shocks. To understand the spatial inconsistencies of the real economy, an explanation of how scale and transportation matter for the location of economic activity is first necessary.
Scale economies matter for the location of economic activity. Overhead and fixed costs due to a firm’s minimum capacity to operate are internal factors to scale economies. On the other hand, local public goods like a road or subway network that supply input services or minimize costs for firms are external factors to scale economies. Economics understands that these differences to increasing returns dependent on spatial organization determines the location of economic activity. Nonetheless, it is incorrect to assume that with lower transportation and transaction costs, location matters less as low costs make firms more sensitive to minor differences between locations. Hence, the interaction of scale and transport costs is what results in a spatial economy.
As such, in a spatial economy, perfect competition cannot be observed as spatial competition argues that firms compete most strongly with its immediate neighbors and not with firms located further away, and so dispersed consumers differ in their access to the same firm. These rational and informed consumers will buy goods and services from firms with the lowest price, where price is equal to the market price plus transaction costs. Firms in a spatial economy thus have some monopoly power and are assumed to behave strategically in respect to other firms. In this model, geographical separation relaxes price competition and a trade-off between a greater consumer base and less competition exists. Given that the welfare of individuals and households are equally affected by the mobility of goods and their production factors, understanding how firms behave and respond to shocks in transportation and geographic variability, is utmost necessary for policy to address challenges like rural inequality around the world.