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Spatial externalities and agglomeration in a competitive industry

William Brock, Anastasios Xepapadeas () and Athanasios N. Yannacopoulos

Journal of Economic Dynamics and Control, 2014, vol. 42, issue C, 143-174

Abstract: We introduce spatial spillovers as an externality in the production function of competitive firms operating within a finite spatial domain under adjustment costs. Spillovers may attenuate with distance and the overall externality could contain positive and negative components with the overall effect being positive. We show that when the spatial externality is not internalized by firms, spatial agglomerations may emerge endogenously in a competitive equilibrium. The result does not require increasing returns at the private or the social level, increasing marginal productivity of private capital with respect to the externality, or location advantages. In fact agglomerations may emerge with decreasing returns to scale, declining marginal productivity of private capital with respect to the externality, and no location advantage. The result depends on the interactions between the structures of production technology and spatial effects as shown in the paper. No agglomerations emerge at the social optimum when spillovers are internalized and diminishing returns both from the private and the social point of view prevail. Numerical experiments with Cobb–Douglas and CES technologies and an isoelastic demand confirm our theoretical predictions.

Keywords: Competitive equilibrium; Social optimum; Spatial externality; Endogenous agglomerations (search for similar items in EconPapers)
JEL-codes: D21 R3 C61 (search for similar items in EconPapers)
Date: 2014
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