Trade, economic geography and the choice of product quality☆

a r t i c l e i n f o The present paper studies the effect of the choice of product quality on trade and location of firms. We discuss a model where consumers have preferences for the quality of a set of differentiated varieties. Firms do not only develop and sell manufacturing varieties in a monopolistic competitive market but also determine the quality level of their varieties by investing in research and development. We explore the price and quality equilibrium properties when firms are immobile. We then consider a footloose capital model where capital is allocated to the manufacturing firms in the region offering the highest return. We show that the larger region produces varieties of higher quality and that the quality gap increases with larger asymmetries in region sizes and with larger trade costs. Finally, the home market effect is mitigated when firms choose their product quality. The present paper studies the effect of the choice of product quality on trade and location of firms. In particular, this paper discusses the role of the size of regions in firms' choice of location and product quality. It is well-known that firms' mobility fosters spatial polarization of economic activity (Krugman, 1991). It is however less clear how differences in region sizes affect the quality produced in each region. Recently, Picard and Okubo (2012) highlight that firms endowed with higher qualities choose to locate in the larger region. Yet, product quality is not an exog-enous factor. Firms invest in research and development to improve their product quality and this investment is likely to affect their decisions about plant locations. Such a relationship between quality and location is a topic that has lacked attention. In this paper we build a quality-augmented version of Ottaviano et al.'s (2002) model where consumers have preferences for the quality of manufacturing varieties. Each firm produces a distinct variety and competes under monopolistic competition. We first consider a trade framework where firms are immobile and choose their product quality. This allows us to discuss the effect of region sizes and trade cost on the choice of product quality and trade patterns. We then consider an economic geography framework in which firms choose both their product quality and location, which highlights the role of investment in product quality in the dispersion of economic activities. We obtain the following results. In the first framework, we show that the …