Firms' locations under demand heterogeneity☆

a r t i c l e i n f o JEL classification: F12 F15 R11 R12 Keywords: Heterogeneous taste and quality Spatial selection Economic geography Agglomeration Home market effect In this paper, we develop an economic geography model in which firms sell product varieties with heterogeneous demands. We show that firms that sell products with higher demand choose to establish their plants in larger countries, which provide better access to the most frequently demanded and valuable varieties. The impact of spatial sorting depends on the skewness of the distribution of demand intensity across varieties. In a model in which only capital moves across regions, demand heterogeneity diminishes the amount of capital invested in larger countries. In a model in which the work force moves across regions, demand hetero-geneity is found to eliminate dramatic changes in the location patterns and to result in the asymmetric dispersion of workers rather than their symmetric dispersion or complete agglomeration in a specific region. The present paper studies the impact of demand heterogeneity on trade and firm location. Firms sell product varieties with characteristics and uses that consumers value differently. Some firms sell product varieties that are highly demanded, whereas others produce varieties with low demand. Firms are therefore heterogeneous with respect to the intensity of demand for their products and consumers' taste and preference for their products. The role of demand heterogeneity in trade has recently been examined by Baldwin and Harrigan (2011) and Foster et al. (2008), who show that exporting firms quote higher prices than non-exporters. The impact of taste heterogeneity on trade has also been presented by Crozet et al., (2012), who show that Champagne and Burgundy wines are exported in larger quantities, to more numerous regions and at higher prices if they receive better quality ratings by reputed wine tasters (e.g., Robert Parker). However, hetero-geneity in taste and demand is also likely to have an impact on firms' location decisions and therefore on the regional composition of industries. The present paper discusses this issue in more detail. The causal relationship between firms' location and their product characteristics is well documented in the business literature. Porter (1990) discusses this relationship as the link between industrial clustering and product sophistication. This author offers many examples of sets of firms that sell higher added value products and choose to cluster in regions with larger markets. For instance, in 1818, Koenig and Bauer …