The phenomenon of a grouping of firms that specialize in producing related products is called a cluster. For example, Ottawa has more than its share of software development firms; Montreal has a disproportionate share of Canada’s pharmaceutical producers and electronic game developers; Calgary has its ‘oil patch’; Hollywood has movies; Toronto is Canada’s financial capital. Provincial capitals have most of their province’s bureaucracy. Clusters give rise to externalities, frequently in the form of ideas that flow between firms, which in turn result in cost reductions and new products.
Cluster: a group of firms producing similar products, or engaged in similar research.
The most famous example of clustering is Silicone Valley in California, the original high-tech cluster. The presence of a large group of firms with a common focus serves as a signal to workers with the complementary skill set that they are in demand in such a region. Furthermore, if these clusters are research oriented, as they frequently are, then knowledge spillovers benefit virtually all of the contiguous firms; when workers change employers, they bring their previously-learned skills with them; on social occasions, friends may chat about their work and interests and share ideas. This is a positive externality.
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