Location as a Signal of Quality
We examine a horizontal product differentiation duopoly model where firms are also differentiated with respect to the quality of their products. Firms first choose their locations (or product characteristics) and then compete in prices. Under full information, it is shown that, whereas the low-quality firm prefers to locate as far as possible from its competitor, the same is not true for the high-quality firm, unless the quality difference is small enough. The paper then suggests an explanation for spatial agglomeration based on incomplete information considerations. Because it is less costly for a high-quality firm than for a low-quality firm to locate close to a rival firm, choosing a location closer to a rival signals high quality.
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