Distance decay for supply and demand potentials

This paper introduces a model framework which identifies the economic activity of each local economy (location) and observes the time distance between each pair of locations. Time distance for interaction inside local economies is taken as reference. Two models of location patterns are formulated on the basis of principles adhering to new economic geography (NEG). The first model describes how business service firms (classified into three levels of knowledge intensity) select locations with a favorable demand potential, depicting a location’s access to customer demand. The second model takes the location of business-service supply as given and describes how other firms select locations with a favorable supply potential, depicting the access to business-service supply. In order to calculate each location’s demand and supply potentials we need distance-decay parameters for interaction outside the local economy. When estimating the two models we develop an approach where the distance-decay (time sensitivity) parameters are determined endogenously as an integral part of estimating location choice parameters. The exercise can be appreciated as a test of NEG principles.