Economics of location

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In economics, economics of location is a strategy used by firms in a monopolistic competition environment. Unlike a product differentiation strategy, where firms make their products different in order to attract customers, the economics of location strategy causes firms to produce similar or identical products.

For example, assume there are two companies selling dye for easter eggs. Each company can sell only one color, and there are six possible colors (red, orange, yellow, green, blue, and violet). If a person can't get their favorite color, they will buy the color that is closest to their favorite (i.e. if a person likes violet, but only blue and green are produced, the person will buy blue). If each color has the same number of people who like it, then the two colors produced will be yellow and green. If one of the companies chooses to produce a color other than yellow or green, the other company can gain a competitive advantage. For example, if one firm produces orange dye, the other firm will choose to produce yellow dye. The first firm will sell only to people who prefer red and orange, while the second firm will sell to people who prefer one of the other four colors. Therefore, it is in both firm's interest to produce similar products (in this case yellow and green dyes). Only then is there an equilibrium, where neither firm can gain an advantage.