In the case of standardised commodities, the units of which are fairly homogenous and where fully competitive supply and demand conditions prevail, it is possible to define rather accurately the economic limits of the tributory market areas of law or more competing markets in the region contiguous to them.
If the example be taken of two selling markets, A and B, which are so located geographically that shipments may be made from one to the other, it is obvious that prices in the two markets can not differ by more than the amount of freight cost between them. If the difference were greater, then the market with the lower selling price would wipe out the market of higher price. Only so long as the price difference is less than the freight cost between the markets can the two markets exist.
Let us now consider the division of territory between the two markets. If the price per unit in both markets is the same and if the freight rates on a mileage basis prevail, it clear that the division of territory will be described by a point on a straight line joining the two markets and half-way between them.
Again, the relation of freight difference to price difference determines the location of this point. The difference in freight cost must equal the difference in price in the respective market for any buyer on the margin or at the point of difference. When the difference in price is O, the area will divide equally. Should the price at B be raised to Tk. 1.20, the price at A remaining the same, the point of division would move to the right by half the amount of the increase, thus restricting B’s selling area and enlarging A’s. The difference in prices would again be balanced by the difference in freight cost, and the two markets would be in equilibrium.
Thus far the explanation applies only to competition along the line from A to B.
What about the division of territory north and south of this line ?
The rule still holds that “the location of the points of indifference in delivered costs to any buyer between two markets is determined by the combination of base prices and freight rates the freight rate from one market may exceed that from the other to any location only by the amount of difference in base prices at the two markets” (Fetter).
In the degree that freight rates varied exactly in proportion to distance and that goods could be shipped on a perfectly straight route from each market to every point in the territories concerned, and that the two base prices were alike to ail buyers, the following general law of market areas would apply :
The boundary line between the territories to two geographically competing markets for like goods is a hiperbolic curve. At etch point on this line the difference between freights from the the two markets is just equal to the difference between the market prices, whereas on either side of this line the freight difference and the price difference are unequal. The relation of prices in the two markets determines the location of the boundary line. The lower the relative price for two selling markets, the longer the tributory area.”—Fetter.
This law is popularly known as Fetter’s Theory of Wholesale Trade Areas.
From an inspection of the above figure, it is clear that only when base prices are equal is the line dividing the territory a straight line . With any other relationship of base prices the boundary becomes a curve, bending around the market of higher price (in the case of selling market) and away from the market of lower price .
In case of both markets prices change at the same time, it is the relative, not the absolute, amount of the change that will affect the shape of the curve. Size of market territories for homogenous products, in the marketing of which freight cost is a significant item, may thus be said to be a function of the differential of market base prices, freight rates remaining constant or a freight rate differentials, market prices remaining constant.