Environmental Policy, Spatial Spillovers and the Emergence of Economic Agglomerations

We explain the spatial concentration of economic activity, in a model of economic geography, when the cost of environmental policy - which is increasing in the concentration of pollution - and an immobile production factor act as centrifugal forces, while positive knowledge spillovers and iceberg transportation costs act as centripetal forces. We study the agglomeration eects caused by trade-os between centripetal and centrifugal forces. The above eects govern rms� location decisions and, as a result, they dene the distribution of economic activity across space. We derive the rational expectations equilibrium, which results either in a monocentric or in a polycentric city, and the regulator�s optimum, which results in a bicentric city. We compare the outcomes and characterize the optimal spatial policies.