Spatial Externalities and Agglomeration in a Competitive Industry
AbstractWe introduce spatial spillovers as an externality in the production function of competitive firms operating within a finite spatial domain under adjustment costs. Spillovers attenuate with distance and the overall externality could contain positive and negative components with the overall effect being positive. We show that when the spatial externality is not internalized by firms, spatial agglomerations may emerge endogenously in a competitive equilibrium. The result does not depend on increasing returns at the private or the social level and location advantages, but on the complementarity between capital and the spatial externality, existence of positive and negative local spillovers, and relatively large deviations between own and other-locations eff ects on the aggregate externality. No agglomerations emerge at the social optimum when spillovers are internalized and diminishing returns both from the private and the social point of view prevail. Numerical experiments with Cobb-Douglas technology and isoelastic demand confirm our theoretical predictions.
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