One of the more interesting out-of-the way corners of the field of Economics is what might be called the pure theory of location. If we assume that consumers are completely rational and have perfect knowledge, that all the retail outlets selling a particular commodity offer identical instances of the commodity at the same price, and that consumers make their buying decisions solely on the basis of how close a retail outlet is to where they are [and of course that all consumers prefer the closer outlet], once one retailer has entered the field, where is the rational place for a second retailer to locate?You might think the answer would be something like: Not too close to the first retailer, but maybe half way between that retailer and the edge of the space in which the consumers are located. You might think that, but you would be wrong. The correct answer is, right next door to the first retailer.
To see why this is so, consider a one-dimensional world in which everyone – retailers and consumers alike – is located somewhere along a line of finite length. [This is of course unlikely, although not more unlikely than most of the other assumptions modern economists make, but my basic point is the same even if folks are spread out in two dimensions, such as in a city.] The first retailer to open a shop commands the entire market. Since there may be some distance beyond which some consumers are unwilling to travel, and assuming that consumers are distributed evenly along the line, the best place for this first retailer to locate is right in the middle of the line, the minimum average distance from a randomly chosen consumer.A second retailer, who decides to enter into competition with the first, must locate either to the right or the left of the center of the line. If she chooses left, she concedes all sales to consumers lying to the right of center, because she must be farther from any of them than is her competitor. She maximizes her sales by nestling right up against the left flank of the first retailer’s shop, thereby snagging all of the business to her left. She and her competitor then can wrangle over who gets the business of any consumers who happen to be located on the dividing line between their two shops.
I reflected on this truth this morning. It rained cats and dogs for several hours, and when it finally let up, we went out for a walk. We strolled up rue de la Montagne Ste. Geneviève as far as rue des Écoles, and decided to have a coffee in a café we had never before frequented. We sat by the window, and I idly looked out the window on the street we had just walked up. There, right next door to one another, were the only two Tibetan restaurants in the 5th arrondissement. “Boy,” I thought, “what on earth can they be thinking, locating right next to one another. Why doesn’t one of them move to rue St. Jacques or Place St. Michel?” And then I remembered my elementary Economics.