Firm Heterogeneity and Location Choice

Heterogeneity in firm productivity affects the location patterns of firm and agglomeration. Here we provide an economic geography model, involving forward and backward linkages driven by the migration of a footloose entrepreneur (capital owner) with different productivity. As a result we find a sorting equilibrium characterised by co-agglomeration of similar productivity firms, however, in contrast to previous studies, unproductive firms are more likely to agglomerate than their more productive counterparts. This is due to the increasingly severe competition induced by productive firms. Productive firms prevent severe local competition through their co-agglomeration. In terms of social welfare, although the sorting equilibrium involves higher social welfare than a perfectly symmetric pattern of firm location, the market outcome is sub-optimal and induces too much agglomeration.