The Spatial Selection of Heterogeneous Quality

Abstract

To explain the spatial selection of vertically di fferentiated firms, this paper incorporates heterogeneous preferences and heterogeneous quality productions into a framework of the footloose capital model, in which labor is immobile. In two regions with identical population size, when trade becomes freer, high-quality firms agglomerates in the region which accommodates more high-skilled labor, whereas low-quality firms move to the region which hosts more low-skilled labor. High-quality firms are more sensitive and more aggressive to take advantage of scale economies in respond to trade liberalization. If trade freeness is high enough, spatial separation of high-quality and low-quality firms between regions emerges. Welfare analysis shows that the individual welfare of either type of labor in either region is better off when trade becomes freer.