HOTELLING THEORY (Subject: Location and Spatial Analysis) Belinda Ulfa Aulia, ST, MSc DEPARTMENT OF URBAN AND REGIONAL PLANNING 2018

Other Location Models Weber’s Model Least Cost Theory Losch’s Model Manufacturing plants will locate where costs are the least (least cost theory) Theory: Least Cost Theory Costs: Transportation, Labor, Agglomeration Losch’s Model Manufacturing plants choose locations where they can maximize profit. Theory: Zone of Profitability Hotelling’s Model Location of an industry cannot be understood without reference to other industries of the same kind. Theory: Locational interdependence

Hotelling’s linear city model was developed by Harold Hotelling in his article “Stability in Competition”, in 1929. In this model he introduced the notions of locational equilibrium in a duopoly in which two firms have to choose their location taking into consideration consumers’ distribution and transportation costs. Hotelling Theory

“Initially the model was developed as a game in which firms first chose a location and after a selling price for their products. In order to set their business in the best location to maximize profits, the firms will have to evaluate three key variables: competitors’ location, customers’ distribution and transportation costs”

Assumption Product was uniform so customers would buy from the most convenient location (nearest seller) and that the friction of distance was linear and isotropic. The total price for the customer is thus the market price plus the transport price (time or effort spent to go to the market).

Hotelling Model The model is usually based on two ice-cream salesmen, A and B, on a mile of beach. The cost and choice of ice-cream is the same for each distributor. Buyers are evenly distributed along the beach. The first pattern of market share has the two salesmen positioned so that each is at the centre of his half of the beach and the market is split up evenly. If A now moves nearer to the middle of the beach, he will increase his market share. The logical outcome of this will have both salesmen back to back at the centre of the beach, as long as some customers are willing to walk nearly half a mile for an ice-cream, i.e. that the consumer provides the transport. This analogy indicates that locational decisions are not made independently but are influenced by the actions of others.

Hotelling's Principle of Market Competition Two competitors will select locations A and B for optimal market coverage. With P1 being the market price, the market boundary would be F1 (point of cost indifference) since right of F1, customers would get a lower price at location B instead of at location A and left of F1, customers would get a lower price at location A. If for any reasons, location A is able to lower the market price from P1 to P2, then its market area would expand at the expense of location B, from F1 to F2.

Hotelling Model… Assume that shop 1 sets What if shop 1 raises xm marks the location of the marginal buyer—one who is indifferent between buying either firm’s good What if shop 1 raises its price? Assume that shop 1 sets price p1 and shop 2 sets price p2 Price Price p’1 p2 p1 x’m xm All consumers to the left of xm buy from shop 1 xm moves to the left: some consumers switch to shop 2 Shop 1 And all consumers to the right buy from shop 2 Shop 2

Locational Interdependence FOR INELASTIC MARKET A Industry first entered the market, then the B industry compete with A If both located in the center, then the market is divided into the same area of the industry Gambar 1.Pada kondisi inelastic, penjual akan mendapatkan market area paling besar jika mereka berada pada titik yg sama. Dengan kondisi transport cost tinggi namun memungkinkan dibebankan kepada pembeli, karena pembeli bersedia membeli produk pada harga berapapun. (harga yg ditawarkan oleh kedua kompetitor sama)

Locational Interdependence If B moves to the right, price lower at the right than the price in the middle If, demand was inelastic (buy the product at any price) then B does not benefit from this location changes Gambar 2. Jika penjual bergerak pada area kuartil maka market area yg ditawarkan lebih besar lagi dan memakan market area kompetitor. Dan harga dapat tawarkan pada harga produk yg lebih rendah.

Locational Interdependence FOR ELASTIC MARKET A and B are two industry colluded to monopolize the market and is located at the position quartile Both divide the market area coextensive comparison with the location in the center, on-site transportation costs higher quartile compared with a location in the middle Gambar 1. Pada kondisi elastic, maka penjual dapat memiliki market area yg sama besar pada harga terrendah jika mereka berada pada posisi kuartil. Pembeli memperhitungkan berapa harga terrendah yang ditawarkan oleh penjual, karena pembeli menanggung transport cost yng diincludekan pd harga jual produk.

Locational Interdependence Advantages located in the quartile exceed the range of possible alternatives Thought Hotteling criticized by Devletoglou (1965) that market area are separated by a line of indifference is unrealistic. Gambar 2. Penjual memiliki market area yg sama besar

Kesimpulan Persaingan antar produsen dalam memperoleh lokasi dengan laba maksimum adalah inti dari Teori Hotteling (Ketergantungan Lokasi) Produsen dalam memilih lokasi industri berprilaku untuk menguasai ‘Market area’ seluas-luasnya yang dipengaruhi oleh perilaku konsumen dan keputusan berlokasi produsen lainnya

Thank you