Firms' locations under demand heterogeneity

In this paper, we develop an economic geography model in which firms sell product varieties with heterogeneous demands. We show that firms that sell products with higher demand choose to establish their plants in larger countries, which provide better access to the most frequently demanded and valuable varieties. The impact of spatial sorting depends on the skewness of the distribution of demand intensity across varieties. In a model in which only capital moves across regions, demand heterogeneity diminishes the amount of capital invested in larger countries. In a model in which the work force moves across regions, demand heterogeneity is found to eliminate dramatic changes in the location patterns and to result in the asymmetric dispersion of workers rather than their symmetric dispersion or complete agglomeration in a specific region. (C) 2012 Elsevier B.V. All rights reserved.