Agglomeration Effects

From Wikipedia:

One of the major subfields of urban economics, economies of agglomeration (or agglomeration effects) describes, in broad terms, it explains how urban agglomeration occurs in locations where cost savings can naturally arise. This term is most often discussed in terms of economic firm productivity, however, agglomeration effects also explain some social phenomenon, such as large proportions of the population are clustered in cities and major urban centres.  Similar to economies of scale, the costs and benefits of agglomerating increase the larger the agglomerated urban cluster becomes. A prominent example of where agglomeration has brought together firms of a specific industry is Silicon Valley in California, USA.

Economies of agglomeration has some advantages. As more firms in related fields of business cluster together, their costs of production tend to decline significantly (firms have competing multiple suppliers; greater specialization and division of labor result). Even when competing firms in the same sector cluster, there may be advantages because the cluster attracts more suppliers and customers than a single firm could achieve alone. Cities form and grow to exploit economies of agglomeration.

Diseconomies of agglomeration are the opposite. For example, spatially concentrated growth in automobile-oriented fields may create problems of crowding and traffic congestion. It is the tension between economies and diseconomies that allows cities to grow but keeps them from becoming too large.

At the foundational level, proximity – especially to other facilities and suppliers – is a driving force behind economic growth, and is one explanation for why agglomeration effects are so evident in major urban centres. While the concentration of economic activity in cities has a positive effect on their development and growth, cities in turn help foster economic activity by accommodating for population growth, driving wage increases, and facilitating technological change.