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Journal of Economic Geography Advance Access originally published online on November 10, 2005
Journal of Economic Geography 2006 6(3):323-346; doi:10.1093/jeg/lbi020
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© The Author (2005). Published by Oxford University Press. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org

Heterogeneous firms, agglomeration and economic geography: spatial selection and sorting

Richard E. Baldwin* and Toshihiro Okubo*

* Graduate Institute of International Studies, 11a Ave de la Paix, Geneva 1202, Switzerland. email <baldwin{at}hei.unige.ch>

A Melitz-style model of monopolistic competition with heterogeneous firms is integrated into a simple new economic geography model to show that the standard assumption of identical firms is neither necessary nor innocuous. We show that relocating to the big region is most attractive for the most productive 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 and the lowest productivity firms to the periphery. We also show that heterogeneity dampens the home market effect.

Keywords: heterogeneous firms, economic geography, estimation of agglomeration economies, home market effect,
JEL classifications: H32, P16
We thank Marc Melitz, Tony Venables and Jan Haaland for suggestions, Virgina di Nino for excellent proof reading and the 4, 5 or 6 referees that looked at this for the Journal of Economic Geography. We especially thank editor Diego Puga for his valuable inputs. Funding was provided by the Swiss National Science Foundation (100012-105675/1).

Date submitted: 27 August 2005     Date accepted: 15 September 2005


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