Cost Reductions in a Hotelling Model with Location Based Spillover Effects

Research output: Working paper

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DatePublished - 2014
Number of pages35
Original languageEnglish

Abstract

This paper analyses whether a firm’s incentive to agglomerate, when research spillovers are location based, survives the existence of asymmetric abilities which may generate heterogeneous unit costs. To address this question we employ a three-stage, innovation-location-price Hotelling (1929) model with quadratic costs and make two key assumptions: i) the closer the firms are to each other, the greater the benefit they receive from their rivals’ efforts in R&D; and ii) firms are a priori heterogeneous with respect to their innovative abilities, defined as the ability to implement cost reductions and assimilate a rival’s research (absorptive capacity). We find two important results. First, agglomeration is never optimal, not even when the firms are symmetric. Simply, the threat of rapidly escalating of price competition is sufficient to prevent even partial agglomeration. Second, where a firm is better able to both reduce its own costs and assimilate a rival's economic knowledge, it becomes more aggressive in terms of both location and investment under location based spillovers. In essence, more asymmetric firms yield increasingly asymmetric outcomes. This result is driven by the existence of asymmetric absorptive capacities. As a more able firm can assimilate more knowledge than it leaks, this increases the firm's ability to be predatory, inducing it to invest more and locate further towards its weaker rival.

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