Question:
In many developing countries, similar types of shops are located in a clumps in the cities, right next to each other. All the motorcycle repair shops will all be on one block, and all the kitchenware stores are all on the next block, etc. Are market forces responsible for this somehow? One source suggested there was a Nash equilibrium at play, but that doesn’t seem to fit. There could be non-market factors like zoning or tradition, but why would that be the case in under-developed countries more than more developed countries?Answer:
This is an interesting observation. We regularly see spatial clustering of similar establishments for a number of reasons including natural advantage, agglomeration economies, zoning, social networks, and "norms" shaping location decisions. The relative importance of these likely varies substantially across countries and industries.
The natural advantage effect is simply that some locations are the best for all individual firms in a particular industry (type of shop) and firms all end up in the same location, even if they would collectively be better off spreading out; this is the Nash equilibrium explanation you mention. Often, similar firms gravitate towards a central location.
Agglomeration economies result when firms are not drawn to the best location per se, but are drawn towards each other because of opportunities to learn from each other, use similar inputs at lower per unit cost, or achieve improved access to customers who like to comparison shop. These are all reasonable explanations but certainly are more important in some industries than others.
Zoning is absolutely a potential factor, and its importance varies across countries, regions, and localities.
Social networks can be powerful forces that encourage some groups to concentrate themselves, both residentially and commercially. Craftspeople in a particular industry may find comfort being around other people with similar skills and experiences; they can talk shop and better understand each other. Subcultures within cities due to religion, caste, class, etc. may also be at work if particular subgroups are heavily concentrated in particular industries.
Finally, many things depend heavily on tradition and norms. New shops in an industry may locate near the older ones in the same industry simply because that is where customers expect them to be. This is related to the “natural advantage” explanation except the advantage of the location is not necessarily natural; it is more historical.
Thus, there is likely no single explanation. Multiple factors are likely involved, though some may be especially important in particular areas.
