Krugman's New Economic Geography

How Paul Krugman explained why economic activity concentrates in a few places, creating cores and peripheries, work that won him the Nobel prize.

Why does economic activity bunch together in certain places rather than spreading evenly? In a 1991 paper, economist Paul Krugman developed a model that became the foundation of new economic geography. He won the Nobel prize in 2008, partly for this work.

The key forces

Krugman’s model combines three ingredients:

Increasing returns to scale: factories become more efficient when they produce large volumes, so firms prefer to operate in one main location rather than many small ones.
Transport costs: firms want to locate close to their customers to reduce shipping costs.
Mobile workers: workers move to where jobs and wages are, and they are also consumers.

The core-periphery pattern

These forces can reinforce each other. If a region has slightly more firms, it offers more jobs and a wider variety of goods, attracting workers. More workers mean a bigger market, attracting more firms. The result can be a core, a concentrated industrial region, and a periphery, a less developed region supplying agriculture or raw materials.

The role of transport costs

Krugman showed that the pattern depends on transport costs in surprising ways:

When transport costs are very high, activity spreads out, since each region must produce for itself.
At intermediate transport costs, concentration becomes attractive: firms gain from scale and can still serve the periphery.
When transport costs become very low, location matters less, and activity may spread again to cheaper places.

Why it matters

The model helps explain the rise of industrial belts, the concentration of industry in regions like northern Italy or coastal China, and why small initial differences, or historical accidents, can lead to lasting inequality between regions.

A historical accident

Two similar regions exist, but a factory happens to be built in one because its founder lived there. It attracts suppliers and workers, which attract more firms. Decades later, one region is an industrial hub and the other is rural, even though they started almost the same. Krugman's model shows how such small beginnings can snowball.

Thinking better roads always spread activity evenly

Lower transport costs can sometimes strengthen concentration, by letting firms in a core region serve distant markets more cheaply. The effect depends on how far costs fall and on other conditions.

Key takeaways

Paul Krugman founded new economic geography in 1991 and won the Nobel prize in 2008.
Increasing returns, transport costs and mobile workers drive concentration.
These forces can create core and periphery regions.
Transport cost changes can increase or decrease concentration depending on their level.