DP4602 Heterogeneous Firms, Agglomeration and Economic Geography: Selection and Sorting

Author(s): Richard Baldwin, Toshihiro Okubo
Publication Date: September 2004
Keyword(s): economic geography, estimation of agglomeration economies, heterogeneous firms, home market effect
JEL(s): H32, P16
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4602

A Melitz-style model of monopolistic competition with heterogeneous firms is integrated into a simple NEG model to show that the standard assumption of identical firms is neither necessary nor innocuous. We show that re-locating to the big region is most attractive for the most productivity firms; this implies interesting results for empirical work and policy analysis. A ?selection effect? means standard empirical measures overestimate agglomeration economies. A ?sorting effect? means that a regional policy induces the highest productivity firms to move to the core while the lowest productivity firms to move to the periphery. We also show that heterogeneity dampens the home market effect.