Agglomeration Externalities and the Dynamics of Firm Location Choices

We develop a new dynamic general equilibrium model of firm location choice that can explain the observed sorting of firms by productivity and is consistent with the observed entry, exit, and relocation decisions of firms within an urban economy. We discuss existence of equilibrium of and characterize the stationary distribution of firms in each location. The parameters of the model can be estimated using a nested fixed point algorithm. We implement the estimator using data collect by Dunn and Bradstreet for the Pittsburgh metropolitan area. The data suggest that firms located in the city are older and larger than firms located outside the urban core. As a consequence they use more land and labor in the production process. However, they face higher rental rates for land and office space which implies that they operate with a higher employee per land ratio. We find that our model explains these observed features of the data well. Finally, we consider the impact of different relocation policies that provide targeted subsidies to new start-ups and superstar firms.