Working Paper: CEPR ID: DP3455
Authors: Keith Head; Thierry Mayer
Abstract: We investigate the hypothesis that firms prefer to locate ``where the markets are." We use a theoretical model of location choice under imperfect competition to formalise this concept. The model yields an equilibrium profit equation incorporating a term closely connected to the market potential index introduced by Harris in 1954. The location decision is a function of demand in all locations weighted by accessibility to consumers. We also show how the spatial distribution of competitors should be factored into the location choice. We then implement the model empirically, comparing our theoretically-derived measure of market potential with Harris' term and with ad hoc agglomeration variables. Our sample consists of firm-level location choices by Japanese firms between 1984 and 1995 and we use both the information on the choice of country and the choice of region inside each country in our analysis. Our results show that market potential does matter for location choice but that traditional agglomeration variables retain an important role in the location decision.
Keywords: borders; European Union; location choice
JEL Codes: F12; F15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Market potential (L10) | Probability of choosing a region (C25) |
| Market potential (L10) | Profitability of a location for foreign affiliates (F23) |
| Market potential (L10) | Elasticity of location choice probability (R32) |
| Traditional agglomeration variables (R12) | Probability of choosing a region (C25) |