Modelling of Agglomeration and Dispersion in RHOMOLO

Abstract

The spatial general equilibrium model RHOMOLO with endogenous firm location incorporates multiple sources of agglomeration and dispersion. Agglomeration is driven mainly by increasing returns to scale and localised externalities; dispersion by costly trade and imperfect competition. In RHOMOLO, three mechanisms interact in determining the equilibrium spatial distribution of agents: capital mobility, labour mobility and vertical linkages as captured by costly input-output trade. While households choose their location based on real income differences, firms' spatial equilibrium is determined by the inter-regional equalisation of returns on capital. Illustrative simulation results suggest that in the EU labour mobility has the tendency to magnify the home market effect and the market access effect. In contrast, the market crowding effect seems to dominate the market access effect for capital mobility and vertical linkages. These results are in line with the theoretical literature, where the endogenous location mechanism of labour mobility contains two agglomeration forces and one dispersion force, whereas the endogenous location mechanisms of capital mobility and vertical linkages contain one agglomeration force and one dispersion force.