This paper examines the use of location quotients, a measure of regional business activity relative to the national benchmark, as an indicator of sectoral agglomeration in small cities and towns, and as a measure of industry specialization that might impact the number of new business startups in these places. Using establishment-level data on businesses located in Maine, our findings suggest that the addition of one "hypothetical" establishment in very small towns leads to a dramatic change in the magnitude of the region-industry location quotient. At population sizes of about 4,100 or more people, however, location quotients are reasonably stable. Regression results from an analysis of the relationship between new business activity and regional industry specialization show that the effect of location quotients on business startups switches from "inelastic" to "elastic" at a population size cutoff of about 2,600 residents. Overall, our findings suggest that researchers and practitioners should exercise caution when using location quotients to study small regions.

Although location quotients are widely used to analyze local industry specialization and identify industry clusters in regions of all size, past studies have noted issues related to the accuracy of location quotients in small places. This paper examines the stability of location quotients in response to a marginal (i.e., one-unit) increase in the number of business establishments, with a focus on small regions. The analysis considers location quotients calculated for cities and towns in Maine, as well as all U.S. counties, and uses a range of industry classifications (e.g., 1-digit and 3-digit NAICS categories). Results show that the stability of location quotients increases with the population size of regions, but they do not uncover a single, universal population size cutoff for the reliable use of location quotients. Rather, the analysis shows that population size, the level of industry aggregation (e.g., 1-digit versus 3-digit NAICS) and even how the data are collected matter in determining the stability of location quotients.

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