Abstract

A Dynamic Firm Location Model with Agglomeration Eternalities

Jeff Brinkman, Daniele Coen-Pirani, Holger Seig

This paper develops a dynamic general equilibrium model of firm location choice, in an environment which includes both agglomeration effects and stochastic productivity shocks. The model builds on the methods of Hopenhayn (1992) and his treatment of firm level entry and exit decisions, by adding the complexity of a second location, as well as the existence of agglomeration externalities derived from spatial concentration of economic activity. We assume that agglomeration externalities increase with employment density and that there is a fixed cost of land. These two assumptions imply that larger firms, with higher productivity shocks prefer locations with high agglomeration externalities relative to smaller, less productive firms. This two-location model allows for the analysis of the dynamics of firm location choice and provides insight into the importance of agglomeration externalities in firm decisions and spatial concentration. In this paper, we present an algorithm for solution of the two-location stationary equilibrium. We then analyze data from Allegheny County, Pennsylvania to describe the spatial concentration of economic activity within a metropolitan area, and find that on average larger firms are more likely to locate in high density areas. Finally, we calibrate the model using this data, to allow for equilibrium and policy analysis. This model of agglomeration externalities suggests policies that could increase welfare by affecting the spatial allocation of economic activity.